What a new Italian government means for markets

Today marks the appointment of Giuseppe Conte as Italy’s prime minister, following an agreement (at the second attempt) between the two leading political parties – Lega and the Five Star Movement – and the Italian president, Sergio Mattarella.

The situation in Italy remains in flux, several months after the country went to the polls on 4 March, with Lega and Five Star between them capturing just over 50% of the vote. Political machinations have caused global stock markets to fall in recent days, although promising signs that a new government will soon be formed have calmed investors’ fears.

Yet questions remain, not least for the equity and bond markets. Given the current instability in the country, wider fears have been raised as to whether Italy might be about to break with the euro. Is “Quitaly” on the horizon at some point soon – and what would that mean not just for Italy but the wider eurozone?

IPE put this question to some of the leading lights in the asset management world and asked for their take on events – and their views as to what might happen next.

FIXED INCOME:

Stefan Kreuzkamp, chief investment officer, DWS:

“Following the [recent] developments, we have become more sceptical on Italian government bonds. For European corporates, we had already shifted to a neutral stance on both investment-grade and high-yield bonds last week.

“In our view, Italian politics could continue to prove a drag on capital markets throughout the summer. Compared to previous episodes of euro-zone troubles, the ECB is likely to have less scope to react. This could add to investors’ nervousness.”

Paul Brain, head of fixed income, Newton Investment Management:

“From here we expect the volatility to continue but the significant yield advantage of other [euro-zone] countries could attract demand…

“They are unlikely to pull out of the euro but the increasing lack of fiscal discipline will not go unnoticed by the northern Europeans. This situation has gained additional significance as the EU moves to debate closer back-stop support for their banking systems.”

Seema Shah, global investment strategist, Principal Global Investors:

“Demand at [Wednesday’s bond] auction was very encouraging, and clearly indicates that investors still have faith in the Italian economy, if not the government.

“Indeed, putting aside the political turmoil, Italy is enjoying a much-improved economic and fiscal position. What’s more, the extended average maturity of its outstanding bonds and a relatively undemanding issuance schedule for the rest of 2018 suggest that Italy is unlikely to face major refinancing problems in the near term.”

April LaRusse, head of fixed income, Insight Investment:

“The two key parties are proposing a range of expansionary fiscal measures… Debt-to-GDP will start to rise once again and credit rating agencies are likely to start to downgrade Italian debt, in contrast to the rest of Europe where credit ratings are improving.

“This leaves us cautious on Italian spreads, especially in an environment where we believe the ECB will be winding down its quantitative easing purchases.”

EQUITIES:

Kristina Hooper, chief global market strategist, Invesco:

“I am certainly not attempting to minimise the risks posed by a possible ‘Italexit’. However, I do believe there is still the potential for upside and that, at the very least, we are likely to see the ECB help to calm markets.

“For long-term investors, it is important to keep in mind that geopolitical risk creates short-term volatility in capital markets, but rarely impacts them over the longer term. In this environment, we should be both vigilant and opportunistic – but not scared.”

Stefan Kreuzkamp, chief investment officer, DWS:

“We keep a positive strategic view, because we continue to see a positive economic outlook for Europe as a whole. Tactically, we have downgraded European equities to neutral and wait for better entry levels.”

Andrea Iannelli, investment director, Fidelity International:

“While Italy’s fundamentals may have improved, there is no room for complacency. The country’s high debt stock means that every additional basis point matters for its interest burden and market moves can ultimately change the fundamental picture.

“Although there are some mitigating factors, investors remain at the mercy of headlines while political tensions remain elevated; volatility will not ease much in this environment and further price corrections may occur.”

POLITICS

Mike Arone, chief investment strategist, State Street Global Advisors:

“In what has been a tumultuous week for European politics, news of the agreement is likely to cool investors’ anxiety regarding an even longer drawn out political stalemate in Italy.

“Panic swelled earlier this week on concerns that fresh elections as soon as this summer would turn into a referendum on Italy’s inclusion in the euro-zone. It may be too early to signal the all clear as the Five Star and League policy plans will further burden an already heavily indebted Italy with an even greater debt load.”

Nicholas Wall, fund manager, Old Mutual Global Investors:

“We believe that there is a very small chance of Italy crashing out of the euro-zone, but the risks of a series of unfortunate events leading to an accidental ‘Italexit’ have increased.

“Notwithstanding the news that Italy looks like it has managed to form a government, the current political situation chimes with Greece in 2015 where the Syriza party won the election promising an end to austerity and questioning the role of the EU. This a useful guide, in our view, as to how the current Italian crisis could pan out. 

IPE will be publishing a Country Report on Italy and its pension system in the July/August issue