Wealth managers try to make sense of the political situation in two major eurozone member states, while they also fret about the rising protectionist noise in Washington DC and Europe.

The outcome of national elections in Italy at the weekend – producing a hung parliament – weighed on investors’ minds at a time when transatlantic protectionism has also reared its head. On the upside, moves to resolve political gridlock in Berlin was seen as a positive move for markets.

On Sunday, Italian voters produced a result where none of the three main factions in Italy would be able to govern alone, with little chance of a return to a mainstream form of government. The outcome again raises questions on whether Italy’s economy can be reformed and withstand the disciplines of the European single currency. 

A rightist alliance including former prime minister Silvio Berlusconi’s Forza Italia (Go Italy!) held the biggest bloc of votes. The anti-establishment 5-Star Movement became Italy’s largest single party. As at the time of writing, media reports (Reuters, other) said the centre-right coalition was on course for 37 per cent of the vote and 5-Star for 31 per cent. The ruling centre-left coalition came in third at 22 per cent. 
At the same time, the long-running negotiations to form a grand coalition government in Germany, following indecisive election results last September, appeared to be bearing fruit, reports said.

Recent days have seen worries rise about protectionism, with US President Donald Trump saying he will slap tariffs on steel and aluminium imports, a move criticised by foreign governments and potentially raising risks of a trade fight. (The move has also been criticised in the US, with commentators saying that higher prices for steel and aluminium will hurt sectors such as breweries and autos.) Fears about global trade added to a sense that the decade-long bull market in equities faces increasing headwinds.

In early trade today, there was some selling of the euro against the dollar, before the rate recovered somewhat, commentators said. At around 10:30 GMT in London the euro/dollar rate was around 1.2330 (source: Bloomberg).

The Euro Stoxx 50 Index of blue-chip European equities sell in very early European dealing time before recovering. (See chart from www.stoxx.com below):

The Italian Job
“The election result is very important for international investors, especially given the size of the Italian economy. While Eurosceptic parties have done well, exit from the euro and EU are low risk. This is because Italy's constitution does not allow for such a vote, and a change in the constitution would require a two-thirds majority, which left and right wing Eurosceptic parties do not command,” Azad Zangana, senior European economist, Schroders, said. 

“The bigger risk is fiscal slippage, and possibly the rolling back of important reforms from recent years. This would put Italy on a collision course with the European Commission, and may even awaken the dormant bond vigilantes,” Zangana continued. 

“A government led by extremist parties could prompt international investors to dump Italian government bonds, causing yields to rise sharply on its huge mountain of government debt worth around as €2.2 trillion or 133 per cent of GDP at the end of 2017. For now, bond buying by the European Central Bank is likely to keep markets calm. However, we do expect quantitative easing to end later this year, making Italy more vulnerable,” Zangana added. 

Nikki Howes, investment analyst at UK wealth management firm Heartwood, said Italian politics looks set to be stuck in a stalemate. “A hung parliament probably maintains the status quo. Note this will be Italy’s 65th government since World War II. A coalition led by a centre-right bloc of parties (with a sprinkling of populist forces) appears to be the most likely outcome. Otherwise, President Mattarella may reappoint the current Prime Minister Gentiloni to lead a new technocrat government until fresh elections are called. None of these outcomes necessarily heralds greater stability, but a worst case scenario of a minority populist government has at least been averted, thanks to electoral law changes last October.”

“Financial markets remain relatively calm and resilient compared with previous sovereign events in Europe over recent years. Much of this sanguinity is down to the economic improvements Italy has seen since the second half of 2017, helped by the recovery in manufacturing, improving consumer confidence levels, and receding deflation risks. A more supportive economic environment has also helped to neutralise some of the more extreme policies of the anti-establishment parties. However, finding consensus to address Italy’s large structural economic problems will prove challenging, given the diverse range of views among the political parties. Italian politics is likely to be locked in a state of paralysis in the near term,” Howes said. 

Grand coalition
While most stock markets appeared little changed overall, perhaps reassured by signs of political progress in Berlin. 

Angela Merkel at the weekend secured a fourth term as Chancellor after the centre-left SPD supported a grand coalition with the Christian Democrats and Christian Social Union parties. German politics has been in limbo since the September national polls last year, which failed to deliver a decisive result. 

“While Germany is getting its political house in order, with the Social Democratic Party having accepted to form a grand coalition with Chancellor Merkel’s Christian Democratic Union Party, Italians are waking up to a possible new world order,” Serge Pépin, director, global equities at BMO Global Asset Management, said. 

“Given the uncertainty and the possibility of a hung parliament, the domestic Italian stock market will likely spend the session today marred in red ink, whilst the general European equity market, currently in negative territory, may find solace following news of Germany’s Grand Coalition. Investors will also likely be concerning themselves with the anti-trade rhetoric of the US President [Trump] and the impact on the continent’s exporters and industries,” Pépin said.