Italian referendum
After years of contentious political debate, the Italian people went to the polls on Sunday to vote in a referendum on major Constitutional reform.
In a country that has suffered dysfunctional government and institutional paralysis, experiencing 63 governments since the Second World War, the Prime Minister, Matteo Renzi, was seeking popular support to streamline the decision-making process, award his office more powers to facilitate the formation of a stable, parliamentary majority, and rein in the powers exercised by the regional administrations. His aim – to provide a national government with a reasonable expectation of lasting a full five-year term, allowing it to defy the vested interests that permeate all aspects of Italian public life, to roll back bureaucracy and to reform the rigid labour laws which have stifled the economy and kept unemployment levels high.
However, as the polls predicted, the Prime Minister lost the vote, with the electorate rejecting the government’s proposals. The size of the loss, however, surprised many, with the Prime Minister resigning shortly after the results were announced. The initial market reaction was stark; Italian equities sold off strongly, with banking stocks the hardest hit; investors fear that the government’s bank bailout programme could be jeopardised, resulting in a potential intervention by the European Stability Mechanism. Italian government bonds are also declining, with yields rising to multi year highs. Wider European stocks have also sold off, with the Euro also coming under pressure.
Whilst this is being portrayed as a rejection of Europe in the British media, the reasons that this referendum failed have more to do with domestic Italian politics. This was effectively a referendum on the government with the public expressing their dissatisfaction with the lack of reform, continued austerity, and the failure to create jobs. Also, in a country which suffered at the hands of fascism, the concentration of executive power that these reforms would have effected made many people wary.
With the anti-establishment, Eurosceptic Five Star Movement riding high in the polls, an early election would see the spectre of populism and political risk return to the Continent. However, this now seems unlikely, with the President instead likely to appoint a caretaker Prime Minister from the governing Partito Democratico so as to provide stability; the current Finance Minister, Pier Carlo Padoan, remains an early favourite. This has calmed markets, with equities rallying from their earlier lows.
2017 European elections
2017 sees Parliamentary elections in the Netherlands and Germany, and a Presidential election in France. The main, ‘establishment’ parties are facing populist challengers whose policies threaten to tear apart the European Union and usher in a new period of financial market volatility. Whilst this is concerning, there remain reasons to be optimistic that we are not staring into the abyss.
Netherlands
In March, the Netherlands will go to the polls to elect 150 new MPs and a new government. The far-right Party for Freedom (PVV), led by the ‘Trump-esque’, blonde-haired Geert Wilders, is currently leading the polls and is predicted to win the most seats. The party supports withdrawal from the Eurozone as well as the wider European Union. Whilst this in itself is concerning, the fractured nature of the Dutch political scene requires parties to form coalitions in order to govern. This naturally dilutes some of the more extreme policy proposals, forcing parties to negotiate a more centrist approach.
France
In April, the French will elect their new President. Marine Le Pen of Le Front National is currently performing strongly in the polls and is almost certain to reach the run off stage. Promising to take France out of the Eurozone and hold a referendum on its EU membership, a ‘Leave’ vote would almost certainly be an existential threat.
Whilst Francois Hollande announced last week that he would not be standing for the nomination of the centre-left ‘Parti Socialiste’ candidate on account of his extremely poor approval ratings (he remains the most unpopular President of the Fifth Republic), the election of Francois Fillon, a socially conservative Thatcherite, to lead the centre right ‘Les Republicains’ party makes a Front National win much less likely. Currently, polls suggest a two-way contest between Francois Fillon and Marine Le Pen would easily be won by the centre right candidate.
Germany
Germany also goes to the polls later next year in Federal elections. Angela Merkel, who leads the centre-right Christian Democrats (CDU-CSU), has recently announced that she intends to seek a fourth term as Chancellor. Although leading the polls by a healthy margin, the Eurosceptic, anti-immigration Alternative für Deutschland (AfD), which was initially created to oppose Eurozone bailouts but has now evolved to oppose German membership of the single currency, continues to gain strength. However, as with the Netherlands, the wide range of political parties, as well as the system of proportional representation employed, ensure coalition governments are the norm.
Brexit negotiations
The Prime Minister, Theresa May, has promised to invoke Article 50 of the Lisbon Treaty before the end of March, thereby commencing the 2-year negotiating period. With still no indication from Downing Street of a strategy, and with the Europeans demanding no ‘negotiation before invocation’, any indication as to how the UK’s future relationship with the EU will develop will be welcomed by investors. However, this promises to herald an unprecedented period of uncertainty, with investors pouring over each and every comment related to the negotiating process. As we saw during the Conservative Party conference, the ‘softer’ Brexit looks, the harder Sterling rallies, and vice versa.
Conclusion
2017 promises to be as equally as tumultuous as 2016, with the Continent facing extraordinary political risks. A rejection of Matteo Renzi’s Constitutional reform could now see elections called early in the year (although, this now seems unlikely after the Presidential intervention), followed by elections in the Netherlands, France and Germany, where right wing populist parties are expected to perform strongly. Whilst the Dutch Freedom party may win a mandate to govern as the largest party, without securing a working majority with parties which oppose many of its policies, it is unlikely to prove a threat. The election of Francois Fillon as the centre-right candidate in France’s Presidential election will in all likelihood obstruct Marine Le Pen path to the Élysée Palace, and Angela Merkel’s decision to seek re-election certainly makes her favourite; a recent poll suggest 55% of Germans would like her to remain in the role.
Investors should be prepared for unprecedented levels of volatility. However, as we saw with the both the EU referendum and the US Presidential election, market reactions can reverse quickly, so short term positioning around certain political events could prove counterproductive.
In many respects, the ongoing negotiations between the British government and the European Union are likely to generate the most uncertainty. Not only will the main power brokers in Europe be preoccupied with elections, but the fact that the governments could change whilst the negotiation process is ongoing only adds to the complexity of the situation. Whilst the UK economy has remained resilient in the months since the referendum, invoking article 50 and setting the UK on the path to an EU exit could prove the turning point, with consumer confidence and inward investment likely to remain subdued until clarity of the future relationship is assured. UK assets, in particular Sterling, are in for a roller-coaster of a year.
Matt Tucker
Investment Analyst
matthew.tucker@quantumadvisory.co.uk