Investors bristle as Italy injects political risk back into 2018 equation
Failure of populists to form government prompts sigh of relief, then fear of long-term uncertainty
At the outset of 2017, fears of a wave of populism sweeping across Europe permeated investor sentiment, coloring what was an otherwise confident mood amid an unexpectedly resilient synchronized global economic recovery.
Elections saw outsider, Euroskeptic parties make inroads, and the year ended with lingering uncertainty, as German Chancellor Angela Merkel’s beleaguered party struggled to cobble together a coalition. But this year began with Merkel’s successful revival of a grand coalition, albeit significantly weakened, to stand alongside French President Emanuel Macron, who had himself staved off an unlikely populist political revolt – for the time being.
In the lead-up to Italy’s recent national elections, the consensus view was that the populist Five Star Movement and League party would fall short of overthrowing the Italian political establishment. It appeared that such an outcome – which would constitute investors’ nightmare scenario – would be averted as it had been in France and Germany, even if only narrowly.
The past few weeks proved investors wrong. Not only did Italy’s two populist parties outperform expectations, but despite having economic policy proposals falling on opposite extremes of the political spectrum, they joined hands to form a mutant coalition with toxic policy prescriptions that threaten to blow up the budget of a country with US$2 trillion in outstanding government debt.
Investors have been dumping Italian assets in the wake of the election. There was a brief pause on Monday in relief that Italy’s president vetoed the populist coalition’s finance minister pick. The move scuttled the Five Star/League coalition’s attempt to form a government but sets the stage for possible new elections and months of uncertainty.
Italian stocks and bonds sold off sharply Monday as markets digested the developments, with the benchmark FTSE MIB index down as much as 2.27%. Italian 10-year yields were up with the spread over German 10-year bonds reaching its highest level since 2014, according to The Wall Street Journal.