Italian Referendum: the mambo-jumbo of predicting the unpredictable

Three days ahead of the vote, the political future of Italy is simply an equation with too many variables, even if you live in Rome, you know the political world and you would be supposed to have better insights on what is traditionally discussed in some inner circles. Therefore, it is way more useful to try to connect the dots among the most reasonable developments according to the most probable realistic scenarios

Pre-Vote Pools

According to the most recent pools, the No-Campaign is ahead by 8-10 percentage points, in line with the general feeling that the protest vote in Europe is a burning fire far from being extinguished. Renzi is supported by a fraction of the Democratic Party and by an undefined percentage of the Italian voters scared by the idea of yet another change in at the government level (Italy had 63 republican governments in 70 years). On the other side, the constitutional reform is strongly opposed by the old leaders of the Democratic Party, the right-centers parties, including former Prime Minister’s Berlusconi party, Forza Italia, and the main opponents, the Five Stars Movement.

Renzi moved backed and forth on his future but, as of today, his intentions seem more defined and orientated toward a resignation, should his reform get rejected by the vote. Clearly the size of the outcome, whether a win or a loss, will represent a key data and deeply scrutinized by observers.

Post referendum future

Should Renzi resign, he will probably receive a mandate from the Italian President in order to form a new majority and it is unclear whether he will form a new government or support the formation of new majority headed by a new prime minister. In both cases, the most realistic scenario is the formation of government dedicated to promulgate a new election law. Based on the new law, a proportional system, the Democratic Party could form a coalition with the Right-Center parties, Forza Italia included, in order to stop the advance of the Five Stars Movement. 

Market perception on Italian assets

Since the referendum announcement day (April 2016), the Italian government bonds remained constantly under pressure and the underperformance of the Italian 10Y generic BTP versus the Spanish 10Y generic BONOS, is a clear sign in this sense.

The spread widening of Italian government bonds has also negative implication for Italy's fragile banking system, still trying to deal with the non-performing loans (NPLs) issue, estimated to total 360 billion euros ($400.7 billion).  As indicated by the most recent Financial Stability Report (Bank of Italy), since 2008 total foreign holders of Italian BTP’s strongly declined while holdings of Italian banks, insurance companies and the Bank of Italy increased. Comparing the FTSE All Share Banks, the main index on the Italian banking sector, and the BTPs 10Y yield there is obviously a clear negative correlation, with some time lag.

Looking at the Italian FTSE Mib, it moved laterally over the recent months and, as the chart shows, any attempt on the short side, below the key 16.000 level, has been rejected. In addition, the 10Y BTP, after having made a top at 2.19%, has now retraced below the 2% key level. In this respect, rumors came about about a possible post referendum ECB intervention in order to mitigate potential potential panic selling on italian bonds.

Is there a tipping point?

For time being markets seem to have prefigured the most optimistic scenario, a change with no substantial change. However, the protest vote, in Italy represented by the Five Stars Movement, is getting more and more ground, fueled by the failures of Renzi's government. It is also worth to remember that Renzi is the third non-elected prime minister, following Monti (2011) and Letta (2013), and the lack of a designated prime minister, since elections in 2008, is creating frustration on people, with politicians accused of having subverted the democratic order. With the actual election law, the Five Stars Movement has reasonable chance to get the majority at both House of Representatives and the Senato and only a proportional law could stop their rise to the power. Clearly, a new italian government headed by the FSM represents the real tipping point for markets, especially in terms of fiscal discipline.

In conclusion, the political message coming from this referendum will be definitely a strong one, but time, months really, will tell whether Italy is moving on a new trajectory or is just the same comedy with new actors.