Italy Populists Seen Softening Policies as Analysts Assess Talks
(Bloomberg) -- An Italian populist government is likely to water down plans for greater spending and any anti-euro rhetoric, a filip for investors in the nation’s assets, market analysts say.
Italian bonds and stocks fell this week after surprise last-minute talks to form a government between the anti-establishment Five Star Movement and League parties ended a deadlock following March elections. Traders are now looking for clues on the potential policies of a coalition perceived as the worst-case scenario before the vote.
The market’s focus will be on a list of ministers, fiscal targets and the level of influence from President Sergio Mattarella and Silvio Berlusconi, according to JPMorgan Chase & Co. Plans including a lower retirement age and a guaranteed income for the poor will probably be scaled back, while Mattarella’s constitutional right to veto ministers is also appeasing concerns.
Appetite for higher-yielding debt and buying by the European Central Bank for its quantitative-easing program should continue to support Italian bonds, while stocks look cheap compared to earnings, analysts said.
Below is a round-up of analysts’ views of the impact of the potential tie-up.
- At face value the electoral programs by League and Five Stars imply a very confrontational stance towards European partners and the risk of large fiscal slippage, which could be consistent with much higher bond spreads between Italy and other euro-area countries
- Since elections, market moves have been consistent with a hefty dose of skepticism on any government’s ability to significantly change the status quo, for better or for worse
- Market pricing has maintained a decent degree of political discount, which on BTPs is probably worth around 25bps
- Program might focus on some changes to pensions, fiscal rules and subsidies, “all likely much less invasive than advertised during the campaign”
- In such a scenario Mattarella is “a key backstop to extreme outcomes,” with critical positions such as finance and foreign ministers chosen to ensure continuity on critical matters (for example deficit and international treaties)
- Short term the market may be afraid of lack of experience and populist nature of government; however, the flexibility of new cabinet would be “pretty limited”
- The coalition’s policies are fiscally negative and will complicate relations with the EU; if discussions fail and there is a move toward fresh elections, it could create further uncertainty, which would also be negative for Italian bond spreads
- While the two movements agree on foreign policy, immigration and Europe, they disagree on most economic topics; “they will have to make concessions, which means much less radical measures than in both of their platforms”
- This coalition would indeed prove tricky for European leaders, even though they are no longer explicitly calling for a euro exit (not Five Star’s leader Di Maio at least). That said, a reform of the asylum system and increased immigration funding could be used as a quid pro quo for progress on EU integration
- Whether or not these two parties are able to agree a joint policy platform, their ideological differences are likely to hamper their ability to affect legislative changes, while raising a question mark over their administration’s longevity
- The market continues to react to the evident build-up of Italian risk with a remarkable degree of insouciance
- Sees no “massive differences” in the electoral programs, hence negotiations might simply require a fine-tuning of their stances; while both programs would trigger a higher deficit, negotiation could moderate the parties’ agendas, resulting in lower potential conflict with EU parameters and to maximize benefits from ongoing macro recovery
- New government could lead to “some question marks” on mid-term sustainability of Italy’s economy
- Remains selective, reiterates preference for cyclical names and “election-proof” stocks such as UniCredit, Eni, Fiat and Buzzi Unicem; stays constructive on banks
- NOTE Feb. 27: Favor Pro-Cyclical Sector Allocation Into Italy Vote: Mediobanca
- A government led by Five Star and the League could put into question the recent structural reforms and fiscal adjustment process. Furthermore it would probably be critical toward Europe, and would be based on a thin majority
- With yields on core bonds still very low, it is likely that a rise in BTP yields will be regarded as a buying opportunity
- Policy measures that could compromise the downward trajectory of the debt/GDP ratio would negatively affect the credit spread, although even in this case the spread BTP/Bund should remain below the 200bps peak seen in 1Q 2017
- Expect Italian assets to remain under pressure as they have been since the prospect of snap elections this year increased, and possibly to deteriorate further should a 5SM-L government be appointed in the near term (even if passively supported by a moderate Forza Italia)
J. SAFRA SARASIN
- Notes that Italy stands out as country with the highest earnings growth rate (20%) in Europe, despite its more subdued economic data; anticipate the “Italian surprise” is not yet fully reflected in valuation multiples, expects Italy’s equity index to sustain its past momentum in coming months
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