THE ITALIAN ELECTIONS: WHAT CONSEQUENCES FOR THE ITALIAN YIELD CURVE ?

Italy is a perfect bicameral parliamentary regime. The government must obtain the confidence of both chambers. The new electoral law (Rosatellum ), introduces an element of majority voting. In each chamber, around 37% of seats will be distributed according to a first-past-the-post (majority) vote and the remaining (approx. 63% ) according to a proportional vote. In each district, a vote for a list (at the proportional vote) will imply a vote for the candidate elected at the majority vote associated with this list (voting for candidates from different lists and lists with different political parties is impossible).

Thanks to this element of majority vote , reaching around 40% of the votes cast would enable a political group (or a party coalition) to be the winner and obtain an absolute majority of the seats in Parliament : more than 316 seats in the Chamber and more than 161 in the Senate.

If you read the current opinion polls, none of the three blocs (PD-M5S- The Right) is able to win an absolute majority of the seats in both chambers.

But , most important , the probability to see the right achieving this objective has increased recently on the back of FI’s good performance in the polls and the rally of Noi con l’Italia (NcI, centrists guided by Raffaele Fitto) to the bloc.

A possible victory of the centre-right coalition led by Silvio Berlusconi would bring the BTP-BUND spread to 100 bps/110 bps (now 130bps) and the BTP 10y yield to around 1.70% - 1,80% (i.e. the same levels reached between December 7th and December 10th, 2017 ) . Why? I think financial markets would appreciate the assumption of political stability that such an election result would lead to Italy.

 An eurosceptic government could be formed only if M5S performed better than the polls suggest ( now they are at 27% - 28% ) and if a coalition agreement with the Lega ( led by Matteo Salvini) was reached. It's almost impossible that the Five Star Movement can get the absolute majority in a "stand alone" scenario. They should gain something like 13 percentage points or more to reach the 40% level and there's no time to gain such a popularity in a very short term (3 weeks ) .

So, the M5S leader implicitly sought a post-electoral alliance with the Lega a week ago, a perspective that could be seen as appealing to the Lega leader, Matteo Salvini . In this case I would see a strong sell-off of Italian government bonds with BTP 10y reaching easily the 2.40% - 2.50% level and the BTP-BUND spread reaching the 180 bps level.

 But let me suggest  the most probable outcome of Italian elections. I think the probability that PD, centrists and FI form a grand coalition has increased very much in the last 2 or 3 weeks , and has become my baseline scenario, on the back of growing popular support for FI. This kind of government would be a short term solution and could lead to new elections in 12 -18 months. The BTP –BUND spread in this case should be stable around the actual levels (130-140bps ) because the fear of Eurosceptic - Populist movement would vanish very soon.

 In case a right-wing government or a grand coalition were impossible, the formation of a technocrat / semi-technocrat government, supported by a national union coalition (from PD to FdI but without M5S and the Lega) would be possible. After few important laws be approved ( new electoral law, new fiscal law and new laws for the economic development of Italy) , a dissolution of Parliament and new elections in H2 2018 would be a risk to seriously consider . In these circumstances , my scenario is a period of high volatility on the long end of the italian curve , because new elections in the fall of 2018 would occur in the same period ECB would end its QE program .

In this case ,  italy’s 10y yield could easily go beyond 2,5% -2,60% level. We have also to consider the risk of higher inflation expectations in the Euro Area, but ( as I pointed out in my recent post dated 15th of February) the inflation take off in the Eurozone is almost impossible (at least for now) seen that there’s no significant wage growth and neither a strong unemployment rate decline.