Eurozone: Italian elections will be the next political risk event - Nomura

The research team at Nomura thinks that in euro area politics, the Italian elections will be the next political risk event.

Key Quotes

“The political crisis in Italy is firing up again with the PD leadership election on 30 April squeezed in between the two rounds of the French election. As it stands now, Mr Renzi would achieve more than the 50% threshold of the vote in the primary election and it is our base case for him to regain his title as PM. However, the market will probably be more sensitive to tail-risks, such as his support dropping below 50%. This would lead to a run-off in the National Assembly, where the worst (an unlikely) outcome in our view is for him to lose the run-off against Mr Emiliano. Mr Emiliano is willing to cooperate with the anti-establishment M5S party. A corporation with M5S would add up to ~56% of votes and be sufficient to rule. That being said, Mr Emiliano is currently polling the lowest and his support has recently dropped relative to that of Andrea Orlando, so we think it unlikely and our base case is a Mr Renzi win.” 

“Importantly, following the ruling on Italicum in January, it is technically possible for an election to be called anytime. An immediate election would likely lead to a win for M5S with some sort of coalition. As such, we think it is more likely for the election to be called after the 16 September (but most likely later), which is also the date by which most MPs will have spent the minimum time in parliament to access the pension/perpetuity for having been an MP.”

“As well, the trade may benefit from the downgrade to BBB/Stable from BBB+/Negative by Fitch on Friday (21 April). Fitch’s rating is now on par with Moody’s, but is still one notch above S&P’s at BBB-. The downgrade reflects a persistent record of fiscal slippage, back-loading of consolidation, weak economic growth, and the resulting failure to bring down the very high level of general government debt, which has left Italy more exposed to potential adverse shocks. Political risks are still high in Fitch’s view and its outlook for the banking sector is negative. This largely reflects the challenge of reducing NPLs, the rate of which edged down to 2.3% in Q4 2016; however, the worst category of loans, sofferenze, increased to €203bn in February, from €199bn in October.”

“In terms of strategy, we are bearish BTPs, which we like to express via a 5s30s BTP steepener with an attractive 10.9bp carry at current levels of 219.9bp targeting 241bp (stop: 208bp). This trade should be supported by the second round of the French election still to come and with more political risk in Italy to follow as mentioned above. In Inflation space, re-denomination risk in France has affected OATis versus OATeis, but further widening seems uncertain. By contrast, we focus on this risk in Italy and expect the 2023 BTPi/BTPei breakeven spread to widen further.”