The Strategist

Political turmoil in Italy stirs local markets

05/17/2018 - 09:34

The League of the North and the Five-Star Movement (Movimento 5 Stelle, M5S), which have been struggling to form a government in Italy since the March elections, can soon reach an agreement. Then, it will open the door to creation of a joint government. All this seems to plunge the Italian markets into shock.

Matteo Salvini, Head of the League of the North party, noted that the talks are at the finish line and that the agreement is likely to be reached on Wednesday. A representative of the M5S made similar assurances. He said that the "government contract" is likely to be published tomorrow.

And, despite the fact that representatives of both parties deny that it was part of their promises, the report says that the new government planned to ask the ECB to cancel the Italian debt of € 250 billion. This shocked the country's bond market, triggering an increase in the yield of 10-year bonds by 12 bp. This is the largest one-day traffic since July 2017.

Italian bonds fell amid news that populist parties trying to form a government are discussing the potential write-off of the huge national debt.

The long overdue sale of bonds, presented by Goldman, sent a spread of Italian-German 10-year bonds to 147 bp.

SocGen strategist Jason Simpson told Bloomberg that "it's all pretty devastating for Italian bonds... the markets assumed they would soften some of their more radical views."

Recall that in recent years, the ECB was the only buyer of Italian bonds.

It is also necessary to eliminate some other complex problems. The leader of the League of the North Matteo Salvini and the head of the M5S Luigi Di Maio still have to decide who will become the next prime minister of the country. Local media reported that they discussed a number of options.

Discussions of the debt write-off were not the only blow to the European establishment. Claudio Borghi, an economic representative of the League of the North Party, said his party would like to "cancel the agreement on financial stability":

"We want to abolish the financial stability agreement... We want to overcome the misunderstanding that there is no money, given that France has exceeded the deficit limit to GDP for the last 10 years, and both France and Spain already have a debt above 60% of GDP."

Italian President Sergio Mattarella agreed to extend the negotiations, since both sides are trying to smooth out political differences, for example, to reverse the changes recently made to the pension system. He also expressed concern about promises of the parties regarding fiscal and foreign policy.

Currently, the strategies proposed by the parties meet the key proposals made during the campaigns: a single tax from the League of the North party and income for the poor from the Five Stars Movement.

Analysts have expressed concern about some proposals for spending, including a plan to reduce the basic tax rate for companies and individuals to 15%. They believe that these proposals may face obstacles in the parliament, as they further destabilize the country's public finances.

Recent media reports referring to sources in the M5S showed that the government contract between the "League of the North" and the M5S will be released "only tomorrow," although this is not the first time that an agreement has to be concluded and everything is falling apart during the talks.