On December 4th, Italy voted ‘no’ on the referendum to strip the Senate of its powers and streamline the way parliament passes bills. Given the strong defeat - only 40 % of the votes were in favour of the proposition - Prime Minister Renzi decided to resign. The market impact remains nevertheless limited, as the ‘no’ vote had already been partially priced in.

What’s next?

We have identified four scenarios, following Renzi’s decision to resign:

  1. The president refuses Renzi’s resignation and asks him to form a new government.
  2. The president appoints a new Prime Minister to form a new government (similar to the 2013 Bersani/Renzi case).
  3. The president appoints a technocratic government to lead the country until the May 2018 elections (similar to the 2011 Berlusconi/Monti case)
  4. New elections are called. This is the case which seems the most dangerous for the Eurozone, as current electoral law is more beneficial to an eventual M5S victory, which could lead to a new referendum on Eurozone membership.

We estimate the third scenario as the most probable one.

Market impact

Compared to other political events of this year, investors and markets already seem pessimistic on the outcome of this referendum. Before the referendum, we already recognized the massive year-to-date underperformance of Italian equities, the BTP-Bund spread-widening and the increase in the 5-year Italian CDS to a 3-year record high.

As the ‘no’ vote was already priced by the market, the market impact today is limited:

  • The euro initially declined to 1.05 (vs USD), before slightly recovering to 1.065.
  • Italian 10-year yields increased to above 2%.
  • The European equity markets have gained more than 1%, while the Italian MIB have only forfeited 0.2%.

Further market evolution will depend on the formation of a new government and the recapitalisation of Italian banks.

No ‘new’ Euro crisis for the time being

From a short-term perspective, financial market stress should remain limited. Despite new elections in 2018 (or before, if called by the Italian president), visibility looks quite elevated. The ECB has already announced that it is prepared to make additional Italian bond purchases in order to limit any confidence crisis. During its next meeting on Thursday 8th, Mario Draghi should reaffirm his commitment to keeping sovereign spreads under control.

From a long-term perspective, the political situation could become even more complex, increasing financial market stress.

Positioning

For the time being, we don’t see any reason to change our current strategy:

  • We keep an overweight in equities versus bonds and are positive on both US and EMU equities. In the meantime, we maintain an underweight in the UK.
  • We have a short duration through an underweight in EMU government bonds, while diversifying towards high yield, inflation linked bonds and emerging debt.

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