November 29, 2016 / 12:01 PM / a year ago

RPT-COLUMN-Italy vote may surprise markets for worse: James Saft

(Repeats with no change.)

By By James Saft

Nov 29 (Reuters) - Italy’s Sunday vote on government reform will likely be 2016’s third major victory for anti-globalization sentiment.

It may also be unlike the U.K. Brexit vote or the U.S. Trump presidential victory in that it will not be a surprise but financial market reaction will be worse than expected.

Prime Minister Matteo Renzi’s package of constitutional reform, which would centralize power, looks set to get the thumbs down from Italian voters December 4, an outcome he has said he would meet by resigning.

That could impede recapitalization efforts by a group of enfeebled Italian banks, notably Monte dei Paschi di Siena , and provide an opening for euro-sceptic political parties which polls show already garner the support of 44 percent of voters.

In turn that could give the European Central Bank reason to re-think if and how it might honor its “whatever it takes” pledge to defend the euro as an institution.

As once-in-a-generation revolutions against economic and political orthodoxy go, 2016 has been a remarkably benign period for investors and financial markets.

That’s especially true given that, unlike the fall of Soviet power in the 1990s, this year’s backlash implies barriers to trade, higher inflation, and lower growth.

The FTSE All-World Index of stocks is marginally higher than where it began the year, U.S. stocks are at all-time highs and the recent sell-off in bond markets seems to have spooked few.

That may be because the reality of pre-exit Brexit is by nature less painful than the long term implications. It may also be because Trump’s plans are seen as good for financial intermediaries and risk given the gamble for economic growth.

Still, while the Italian vote has little of the shock and awe of the other two, and has drawn fire from prominent defenders of the existing order for not going far enough, a “no” vote does have the potential to ignite the kind of brush fire which spreads in dry weather.

“The political atmosphere isn’t getting any less fraught. In many parts of Europe, we see widespread dissatisfaction with globalization, the rise of populism, and a frustration with incumbent politicians. The consequent rise in popularity of anti-elitist politicians is gaining ground with unpredictable consequences,” Colin Moore, global chief investment officer at Columbia Threadneedle Investments wrote in a note to clients.


In the event of a “no” vote, the immediate issue is who governs Italy and under what mandate.

Deutsche Bank analysts argue that a “muddle-through” compromise is one strong possibility, with or without Renzi.

In either case the likely outcome would be another attempt at electoral reform next year but little progress on the fundamental economic issues, thus potentially increasing the popularity of the broad array of parties who object to the euro project.

Even more upsetting would be a call for an early election, maybe early in 2017 which could lead to a non-binding referendum on support for the euro itself.

Note that spreads of Italian 10-year government bonds over German peers were at about 190 basis points on Monday, the highest such premium investors have demanded for more than two years.

This is not the kind of backdrop you want if many of your banks are seeking to raise capital, and some of which may otherwise need to seek government support which could trigger politically painful losses among bondholders, many of whom are small retail Italian investors.

Also of concern is the way in which all of this could serve to sideline the European Central Bank, the one European institution which has moved both with dispatch and great effect at times of crisis.

“The rise of euro-sceptic parties could prevent the pro-active use of the ECB’s OMT - Draghi’s 2012 ”whatever it takes“ - in a post-QE world,” Marco Stringa and Simon Carter of Deutsch Bank wrote in a note to clients.

The ECB’s Outright Monetary Transaction program, which provides for buying bonds, has been in part predicated on cooperation towards what it views as reform. Discussing euro exit from a position of political power might not be viewed inside the ECB as consistent with reform.

This makes an interesting parallel with the way in which the advent of Trump as U.S. President-elect seems to have transformed the role of the Federal Reserve.

While the Fed two weeks ago was seen as a safety net, the implication of Trump’s taxing and spending plans, if implemented, is that the Fed will now tighten monetary policy more aggressively.

In other words, the former savior could become a purveyor of risk.

Central banks tried to save globalization from itself in the wake of the 2008 financial crisis, but once it begins to unravel they may be of less use.

At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at and find more columns at James Saft

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