- Markets should have anticipated Italy’s election outcome, but recent elections elsewhere had bred a deceptive sense of calm. Expect wider spreads and more volatility as markets get buffeted by political news.
- With France shying away from austerity, peripheral countries are questioning their own agreed-upon austerity measures—and Germany is questioning why they should help out (again).
- The EU will look to the fragile fiscal compact to hold populist policies in check; we may see euro-zone economic woes broadening from the periphery to the core.
- As Germany heads toward autumn elections; as Spain, Italy and France are increasingly politically paralysed; and as the US struggles with sequestration, investors must appreciate that politicians will not or cannot act.
- It’s all down to the global central bankers, who have few options but printing (more) money. It’s time to look for looming signs of inflation because when it comes, it tends to come as a shock.
Politics has returned to haunt global markets with a vengeance in recent weeks, first through the Italian elections and then with the return of sequestration in the US. Both events are related, revealing a lack of political will and an inability to implement clear policy. From a European perspective, though, the Italian election results have deeper and more serious consequences for the solving of the euro-zone debt crisis and mark a return to greater market volatility. We will therefore focus on the election outcome in Italy and why central banks have returned to save the day – again.
Results of Italian elections
The Feb. 24-25 elections in Italy saw, as predicted, no clear government elected and looked suspiciously like a revolt against austerity and cuts by the Italian people (see table).
(% of votes)
(% of votes)
|Centre-left (Pier Luigi Bersani)
|Centre-right (Silvio Berlusconi)
|Centrist (Mario Monti)
|Five Star Movement
- The centre-left Democratic Party, led by Pier Luigi Bersani, did well, winning a majority in the Lower House, but did not get sufficient votes to gain a majority in the Lower House and the Senate.
- The surprise lay in the size of the protest vote for comic and blogger Beppe Grillo and his three-year-old Five Star Movement, who won a much larger percentage of the vote than had been expected. Populist Grillo is anti-austerity and also anti-old-world politics compared with technocrat Prime Minister Mario Monti (whose austerity plans made him unpopular).
- The Italian President, Giorgio Napolitano, will now ask Pier Luigi Bersani to form a government and if, after a couple of weeks, still no government has been formed, a second election will be held in late April or May. Bearing in mind that presidential elections are scheduled for 16 April, with Giorgio Napolitano due to step down on 15 May, we face the possibility of a country with no government.
We believe that markets should have anticipated the outcome of the Italian elections, but recent elections elsewhere have bred a deceptive sense of calm – up to now, that is. We should now expect to return to the usual widening of spreads in Italian and other periphery bond and credit markets and see levels of volatility rise again as markets are buffeted by politics – plus ça change!
Economically, Italy was already in recession, with expectations of a 1.3% decline in gross domestic product (GDP) in 2013, so a further period of uncertainty will not help boost investment, spending or other positive decisions. However, rising bond yields will temper any political foolishness and act as a measure of discipline and this is good, in our opinion, because Italy needs a small amount of austerity to achieve a primary surplus – although this is harder to achieve when growth turns yet more negative.
All eyes now on Paris?
Moving away from the peripheral euro-zone countries, it is worth focusing on developments in France, where we are seeing an end to any further austerity this year and some “mañana” spending cuts next year. This is important because France is at the core of the European Union (EU) and if it does not even attempt to follow the rules it has set for the peripheral countries, it raises the question of why any of them should remain on the agreed painful path of austerity. Also, in a crucial German election year, this will bring many Germans to question why they should help out (again).
Expect this unfolding drama to centre further attention on European Central Bank (ECB) President Mario Draghi and the ECB, where again there are mounting tensions. While Draghi saved the EU last summer with his Outright Monetary Transaction (OMT) ideas and, thus far, talk has been very effective in buying time, unfortunately it is time that has been wasted by EU politicians. Now Draghi may need to “walk the walk” but only if EU politicians have a credible plan for which Germany is prepared to pay.
The view from Berlin
While respecting the will of the Italian electorate, the German government must be disappointed that so many Italians voted for anti-austerity parties (such as Beppe Grillo’s Five Star Movement) or anti-EU parties (such as Silvio Berlusconi’s centre-right party), particularly as this goes to the heart of the disconnect between Brussels and the European electorates. They will expect whatever government is ultimately formed to follow through on their promises and policies, but will find it harder to promote greater restructuring, or even further restructuring, in the economy. While they must remain supportive of any coalitions which may be attempted or formed, they will know that the hold on power will be fragile and weak, reflecting over 60 Italian administrations since 1945.
The solution? Obeying the fiscal compact
The EU will be relying on the fiscal compact, agreed upon last year and implemented this year, to constrain any populist policies in Italy and elsewhere. However, since both Germany and France broke the Maastricht criteria in the early 2000s, it is not clear that a possibly fragile new Italian government would adhere to the criteria either. With poor economic progress in Portugal, Spain, France and now Holland as well, we should be prepared to face the broadening of economic woes from the periphery of the euro zone to the core.
ECB to the rescue – again
Around €140bn has been repaid within the ECB’s Long-Term Refinancing Operation schemes, as banks can access markets for cheaper short-term debt and as international investors have returned to many EU markets following Mario Draghi’s OMT speech last summer. However, this may only be a short-term positive, as further political trouble may again impact liquidity. This will then see the resumption of TARGET2 lending, still more than €600bn from the ECB, and flight of deposits from the weaker states again. As before, the link between the banks and the sovereigns remains unbroken.
Importantly, as Germany heads towards an autumn election and Spain, Italy and increasingly France are politically paralysed from new or further policies, all will rest on the ECB and Mario Draghi. His summer comments to do “whatever it takes” are likely to be tested this year and, if conditionality is imposed, politicians will be unable to deliver – thereby exacerbating any recession. If there is only token conditionality, the ECB will join all other major central banks in full quantitative easing (QE) monetary printing, and the collapse of confidence in paper money may begin.
Central bankers save the day
With no clear government in Italy, scandal in Spain, stresses to the ruling coalition in the UK, the sequestration and “fiscal cliff” in the US and the new determined Japanese government intent on inflationary reflation, we believe global investors must now fully appreciate that politicians will not or cannot act, with the result that it’s all down to global central bankers. This raises two main concerns: First, there is no evidence that QE and related policy stimulate economic growth – though it does save banks; second, all previous interventions in history have generated high inflation.
In this financially repressive world, we have arrived at a point in both economic and political terms which warrants particular caution, in our opinion. With the US subject to automatic spending cuts on the back of renewed political squabbling, Italy in post-election chaos and the euro zone fighting a seemingly never-ending debt crisis, the world’s central banks are left with little option but to print (more) money to stave off the worst effects. As a result, it is time to scan the economic horizon for looming signs of inflation because when it comes, it tends to come as a shock.
At Allianz Global Investors at this time, we are especially vigilant and on full alert in terms of monitoring market developments and watching out for our clients’ assets. As the saying goes, “forewarned is forearmed”.