Euro Politics: Shift in polls might trigger early elections in Italy – Regional elections in Sardinia resulted in a significant loss for the Five Star Movement (M5S) last Sunday. The populist left wing party had already suffered a blow at the regional elections in Abruzzo earlier in February. Both regional elections were comfortably won by right wing or centre-right parties or candidates. The leader of M5S (Luigi Di Maio) and the leader of its current coalition partner in the national government, the populist right wing Lega (Matteo Salvini), as well as prime minister Giuseppe Conte all reacted by stating that this regional result would have no implications for Italy’s government at the national level. Still, recent opinion polls for the government at the national level have also shown a significant shift in popularity away from M5S and towards its coalition partner Lega. Indeed, during the last general election on 4 March 2018, M5S turned out to be the biggest party, with almost 33% of the votes, while the Lega came third, with around 17% (the centre-left Democratic Party came second with almost 19% of the votes). The most recent polls have shown the opposite picture, with Lega well ahead of any other party. According to the latest polls Lega would win an election and get around 33% of the votes, versus 23% for M5S.
Moreover, the right wing coalition that was formed before the March 2018 election by Lega, Forza Italia, Brothers of Italy, Nci and Union of the Centre, would get almost 50% of the votes. Therefore, a majority centre-right coalition government seems to be within reach, which would be Mr Salvini’s preferred coalition. As such, we think the shift in the polls could trigger early elections, potentially around the end of the summer. Around that time, the first draft for the 2020 government budget needs to be made. Also, it should have become evident around that time that the 2019 budget deficit will be considerably higher than the government’s target. The European Commission would put pressure on the Italian government to carry out fiscal consolidation. This should fuel the tensions between M5S and Lega, particularly considering that they are positioned at the opposite sides of the political spectrum, with Lega mainly representing the wealthier Northern regions.
We see rising risk of early elections but not yet our base case – Given the recent polls and these potential tensions, the chances of early elections in Italy have increased, though it is not yet our base scenario. We think the Lega leader would want to be confident that a right wing coalition would win before trying to engineer a government collapse and new elections. With the coalition polling at 50%, it is probably not sufficient for Mr Salvini to be confident in getting sufficient votes for it to form a coalition government with a clear majority.
Our current base case for this year – which assumes no early election – sees the 10y yield spread of Italian government bonds over their German counterparts rising to 300 bp. The Italian economy is in recession and the budget deficit is likely to significantly overshoot the government’s target. In addition to likely further disappointments in terms of the macro outlook (we see GDP of -0.3% this year versus the government’s projection of 1%), we think that the measures that the government has implemented will be more expensive than the budget assumes. Overall therefore, we expect the budget deficit to be considerably higher than projected, at close to 3% GDP in 2019 and 2020. Given this, we remain of the view that the government debt ratio will trend up in the coming years. With fiscal outcomes likely to disappoint, markets may price in more credit risk, especially as this could re-ignite tensions with the European Commission.
What if …What would early elections mean for financial markets? Elections usually lead to uncertainty and push up risk premiums. However, if it is clear to investors that the right wing coalition would win a majority, this would likely be a more market friendly outcome than the current all-populist coalition. Fiscal outcomes may be better if the government only needs to honour ‘right wing’ promises. Indeed, markets seemed to be pricing in a right wing coalition before the last election, when spreads were much lower than now (at around 130bp). Lega would play a bigger role then than now, and fundamentals have deteriorated since then, so we would not expect spreads to return to the levels seen at the start of 2018. Though significant spread compression could be expected on the basis of a right wing government scenario. (Aline Schuiling and Nick Kounis)
China Macro: China’s piecemeal easing approach set to continue – Recently there have been some mixed signals regarding how far Chinese policy makers are willing to go with stimulus in terms of safeguarding growth (versus putting financial stability at risk). In our view, ‘mixed signals’ are pretty much business as usual, given that various policy makers have different roles and backgrounds. What is clear is that, with the Chinese economy facing headwinds from previous financial deleveraging and the trade conflict with the US, Beijing has put macro-economic stabilisation at the top of the priority list while (financial) deleveraging has been shifted down. At the same time, Chinese policy makers are still constrained by longer-term goals, such as stabilising leverage and tweaking China’s growth model to safeguard long-term growth and prevent future rating downgrades. That explains why policy support is not coming in ‘big bazooka’ style, but rather is being unfolded by means of a wide range of smaller targeted fiscal and monetary easing steps. The overall size of this stimulus is smaller than for instance the measures taken during previous China wobbles in 2015-16 and certainly than the massive package rolled out during the global financial crisis in 2008-09. For instance, the benchmark policy rate has been kept on hold this time versus cuts of over 200 bp in 2008-09 and 165 bp in 2014-16. We expect the piecemeal easing approach to continue. That said, it seems that the shift from financial deleveraging to targeted easing has started to filter through, for instance in overall credit growth. The January lending data pointed to strong credit expansion, although these data are partly distorted by seasonal effects in the run-up to the Lunar New Year. We also see some green shoots in terms of activity data. On the US-China trade front, latest developments are also positive, with an extension to the 1 March deadline on the cards. All in all, China’s economy has slowed, but we expect economic growth to stabilise in coming months as headwinds are ebbing. For more background also see our latest China Watch, Will the pig arrive in time this year? here (Arjen van Dijkhuizen)