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Olly Russ: Renzi loses Italian Job

Posted in [Fund Managers' Blog] By Olly Russ

As both betting markets and opinion polls predicted (for once), Italian PM Matteo Renzi lost his referendum for constitutional reform, and with it his job. Although the polls were correct in predicting the outcome, they understated the emphatic margin by which the proposals were defeated, which now look to be 59:41 in favour of a ‘No’. Renzi took the hint, and in a somewhat rambling speech eventually managed to announce his intention to tender his resignation later this afternoon.

Investment banks were flagging possible falls in the market of more than 4% this morning, and indeed the European markets opened down and remained in negative territory for very nearly a full five minutes. By 9.30, Europe was up 1.25%. Italian banks, the epicentre of the crisis, fared less well with Unicredit down nearly 6% at one stage before rallying almost back to flat. Banca Intesa though is up c. 0.8% currently.  On the currency side, Eurosterling spiked to 1.2040 overnight, the highest since July and sees sterling up over 10% against the euro since the Brexit lows, before falling back to close to unchanged. Why the sudden bullishness?

As we mentioned last week, considerable short positions had been built up by hedge funds going into the vote, and the word from Milan is that there is considerable short-covering this morning. Much though is also in the price, with Italy the worst-performing European market year to date, and now also the cheapest, trading not far off crisis levels. That said, the recovery in Italy has also been amongst the weakest, and the earnings recovery in particular the weakest of any major European country, principally due to financials.

Of the possible developments we outlined last week, it would appear that the likelihood of the President refusing to accept the Renzi resignation, or Renzi forming a new government, has severely diminished due to the size of the losing margin. The options are now a new technocratic-style government, possibly charged with limited electoral reform before moving to new elections in a year or so, or more immediate elections, as demanded by the Five Star party.

The constitutional state of play is now that the Senate remains safely unreformed, but the Italicum law, whereby the winner of the election gets control of the Lower House, remains in force. The Italian Establishment would rather see that law adjusted before an election, fearing that if Five Star were to win – as on current polling they would in the run off – they would form the next government, with all that this implies for a further referendum on euro membership. The plan is to adjust the law so that a winning coalition takes a bonus majority, rather than a single party. Since Five Star don’t really do coalitions, this would mean they would have to get an outright majority to form a government, an unlikely situation.

In the short-term, the front runner for PM is the Minister of Finance, Pier Padoan, to head up a technocratic government. As an economist, former director of the IMF, consultant to the World Bank, EU and ECB, and vice-secretary of the OECD, he has impeccable Establishment credentials, although how useful that will be when it does eventually come to elections remains to be seen. He is of a fiscal expansionary mindset, and may be able to persuade the EU of the need to allow a more generous budget for Italy.

At any rate, investors will be hoping that the Italian president will emulate the original Italian Job and Get a Bloomin’ Move On when putting together the next government, as it is now self-preservation time for the Italian banking sector, which is in the middle of a complex process of bad debt resolution and recapitalisation which requires firm and stable political leadership as a backdrop to be successful.

Although market reaction is at an early stage and things could yet reverse, the prophecies of doom heard last week seem currently wide of the mark, with no real apparent signs of stress in the wider European banking system. These days it seems that the buy the dip mentality is so ingrained, that sometimes investors don’t bother waiting for the dip.

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