#Market Strategy — 06.12.2016

"No" Prevails At Italian Referendum

Paolo Gianferrara

The “NO” win by almost 60% will trigger a period of political uncertainty and a likely setback for the recapitalization of the banking sector. After significant volatility in the short term, markets should recover thanks to ECB support and more visibility on political outcome

No won by around 59,1%

On December 4th Italians were asked to approve a constitutional reform, strongly supported by Prime Minister Renzi.

  • Strong participation : around 65,5%

  • “NO” prevails by a comfortable margin

A constitutional referendum combined with a political stake

The constitutional reform essentially aimed at revising the ‘perfect’ bicameral system which conditioned the enactment of each new legislation to a double vote of confidence in both the lower house (Chamber of Deputies) and the upper house (the Senate).

In order to achieve this objective, the Chamber of deputies, alone, would be able to approve new laws, vote the confidence to Government and approve the national budget while the Senate would become a consultative regional assembly, made of 100 senators (from 315) no longer directly elected by citizens, which only retained vetoes on constitutional, local government and key European Union issues.

Mr. Renzi argued that the package would streamline law-enforcement, reducing overlap between local and central government bodies, and that it would end political instability while modernising Italian political architecture.

The opposition to this reform was strong during the campaign. It encompassed different factions such as the Five Star Movement, other opposition parties and even some dissidents within Renzi's Democratic Party. It argued that the reform would undermine democratic checks and balances, granting the executive too many powers, and producing minimal cost savings.

Finally, the opposition took profit of the referendum campaign to require anticipated political elections would “NO” prevail making of this referendum a vote on Renzi reformist government and not on the constitutional question which was effectively asked.

Markets’ expectations

Ahead of the referendum, Italy-Germany 10yr yield spread experienced a strong widening approaching post-Brexit highs, just  below 200bp, amid speculation that a NO  vote would lead to prolonged political instability with the risk of a  new peripheral crisis.

However, there was a high uncertainty over the referendum outcome, namely due to the high percentage of undecided voters, exceeding 20% On equity markets, Italian bank and insurance sectors were under strong pressure on renewed concern that a “NO” win would undermine the ongoing recapitalization process of Banca Monte Paschi with a spill-over effect to all financial sector.

What will happen next ?

After exit polls’ outcome was made public, Mr. Renzi announced his decision to step down. This triggered a period of political uncertainty which should end as soon as  there will be visibility on the way forward.

Today, Mr. Renzi will meet Italian President, Mr. Mattarella, in order to tender his resignation. The latter will then start consultation in order to choose among different options such as :

  • Appoint a caretaker government made of an interim coalition of political formations, possibly led by a technocratic figure. The new government would then focus on most urgent issues such as the recapitalization of Monte dei Paschi and other similar banks and revising the electoral laws in the perspective of new general elections

  • Dissolve Parliament and call early elections to form a new political majority. This options seems though quite unlikely since electoral laws would have to be revised first and this would probably postpone the polls by 6 months

  • Give a new mandate to Renzi. This option seems though very unlikely due to the wide margin of the “NO” win.

Our conclusions

In general markets will likely consider this “NO” win as a “negative” outcome for both political stability and the economy in Italy. 

Hence, even though a “NO” win has probably been already priced in by the markets, we expect, in the short term, a significant widening pressure on subordinated paper of Italian insurance and banks as well as some more downside on stock markets, especially on banking sector.

However, the short-term reaction should be then mitigated by ECB meeting scheduled on Thursday, Dec. 8th. ECB President, Mr. Draghi, is due to announce his final stance concerning a potential extension of asset purchases at the current pace of 80bn€ a month. Considering the referendum outcome, Mr. Draghi might wish to re-assure markets providing a further stimulus to European economy.

Some investors might also be tempted to take a tactical position on BTPs in case of likely spread widening and in the perspective of  strong ECB support.

Once the short term volatility will decrease, markets will probably remember the “NO” win first and foremost as a missed opportunity for reforms rather than a trauma for the country.

Initial markets’ reaction

  • Negative but not dramatic
  • EUR trades around 1,06 against USD
  • BTP/Bund spreads widen by 10 bps
  • Futures on EuroStoxx 50 at -0,43%
  • FTSE MIB opens at -2%