Italian Political Problems
Mounting disagreement in the Italian ruling coalition has eventually led the Lega’s leader Matteo Salvini to call for new elections. The head of the upper house of the Italian parliament has re-summoned the house from recess today. It aims to set a date for a no-confidence vote on the Italian Prime Minister.
This will be the first step towards a possible new Italian government or fresh elections. According to the press, in yesterday’s meeting with the head of the upper house, parties had two different opinions. There were those wanting to hold the no-confidence vote already on 14 August (among which Lega). Lastly, there were those wanting to postpone it until the latest possible date, 20 August.
Recent events make it highly unlikely the Italian government will survive the vote. Having called the vote, Lega will almost certainly vote against its own government. Market watchers see little reason why opposition parties might come to its rescue. So, in all likelihood, next week will mark the end of the Lega-Five Star Movement coalition government.
It is a close call whether Italy will end up having fresh elections or a technocratic government in place. This uncertainty could go at least until the beginning of next year. Italian president Sergio Mattarella faces a tough choice. On the one hand, he might be cautious on elections without a budget in place. On the other, the current parliament composition is at odds with the polls. Impeding elections could be unpopular with voters. For that reason, elections in October are a slightly more likely outcome. Yet it is a close call mainly if there will be further delays in the no-confidence vote. Markets expect more clarity in the next few days or a couple of weeks at the latest.
From a market perspective, a technocratic government is a favourite at least in the near term. Markets tend to dislike the uncertainty brought by an election, and the related market volatility. Markets might also be wary of the risks associated with a far-right euro-sceptic party such as Lega. However, if elections are off the list now, a technocratic government might not last long, either.
Balance of Risks
The balance of risks for the EUR and Italian bonds shows a tilt to the downside moving ahead. During the weekend, former prime minister Matteo Renzi showed interest in forming a coalition with the Five Star. With the partnership, he wants to deliver the 2020 budget and avert a VAT tax hike. This option could provide some short-term respite to market concerns. However, it has been fiercely opposed by the current Democratic leader (Nicola Zingaretti) and a large part of Democratic MPs. Nonetheless, Renzi still has several followers in the parliament and may ultimately have enough seats to govern with Five Stars. Remains to see whether Five Stars would accept the deal.
With uncertainty abounding the EURUSD is currently pegged to rotating around the 1.12 level, while the market awaits further information. A negative market response to Italian political developments will likely see the current rage pivot of 1.1220/50 cap the current correction. The market will probably retest year-to-date lows. It has the potential for the downside to extending to test the lower descending trendline support around 1.0950. A positive market response to political developments would see a retest of 1.13 trendline resistance. A two-day closing breach of this level would encourage further recovery to test offers above 1.14.