In February 2018 I predicted markets would tumble in May due to the Italian elections. And again in a ‘Bloody October’ for stock markets later that year.
Both played out, although the ECB managed to paper over the problems in the end. The crash of October, which began a little ahead of schedule, was still the worst since 2008 by many measures. The ASX200 lost almost 1,000 points.
These days, Italy’s bond market is suspiciously calm. But Bloody Sunday could change all that. And if we’re back to 2018 levels, that could sink markets all around the world once more.
So let’s look into what’s going on.
As I predicted in my book How the Euro Dies, Italy’s coalition government didn’t manage to hold up for long. But what I didn’t see coming is the reformation of a new coalition between mortal enemies Five Star and the Democrats, instead of new elections.
The most extreme anti-establishment party formed government with the ultimate establishment party, just to keep things ticking over. Just to keep the right wing out, despite them topping the polls at the time.
Unfortunately, democracy is a game of deadlines. There’s always another election. Lega was kicked out of government when the coalition failed, allowing it to consolidate support by not having to be politically correct and compromise anymore. And on Sunday, we’re going to get our first taste of what this means at the polls.
The elections are for the region Emilia-Romagna, where spaghetti Bolognaise comes from, I think. Now you might think that regional elections are hardly crucial. But don’t forget that financial markets think ahead. They price ahead too. And such elections add a lot of data to projections of the likely future.
As Bloomberg sees it, the regional elections signal that ‘Italy Prepares Itself for Prime Minister Matteo Salvini’. Such a victory for Lega would ‘cement his role as Italy’s prime-minister-in-waiting’.
This is a man who called the euro ‘one of the biggest economic and social crimes ever committed against humanity’ and said it won’t survive…
But he’s polling at the same levels as the incumbent left in the region. Which doesn’t sound like a seachange, but it is. ‘Emilia-Romagna region has supported the left since World War Two’, Bloomberg points out. They call it Red Emilia for a reason. At least, they used to call it that. It’s about to go Lega black, ironically thanks to a lot of immigration from Africa…
With Five Star giving up its last vestiges of being anti-establishment, Salvini is soaking up the votes they once held. Alongside allies, he’s polling close to 50% in a threeay race on the national level. Hence the prediction he’ll win any national election and form power off his own back next time around.
Why does all this matter? Well, the prospect of a Salvini government sent markets into a tailspin in 2018, twice. The topic at hand is a major financial crisis similar to Greece’s, but on a much larger scale. And in a nation which never experienced the boom, Greece did before its bust.
The underlying issue is a devil that’s hidden in a lot of detail. The ECB’s capacity to print money to rescue Italy is beholden to certain conditions. One of them is compliance with an EU prescribed austerity program, or having their budget approved by the EU. In other words, to get access to the ECB’s printing press, you have to behave, or at least get permission to misbehave.
But not behaving is the one thing Lega is all about. It’s what Five Star used to be all about too. But when the two were in coalition, they calmed things down. And when Five Star changed sides, they gave up on looking populist altogether. While Lega has had free reign to claim whatever they like, outside of government.
Which leaves Italy’s legions of the upset to vote for Lega and Salvini if they want to make a point. And that’s what markets fear — Salvini making a point.
Back to our devil in the detail. Matteo Salvini may be paying lip service to the euro these days. But it’s pure showmanship. He’s going to present the EU as the power that forced Italy out of the euro by making the country choose between controlling its own fiscal policy outside the euro, or not controlling it inside the euro.
Salvini will promise voters to present the EU with a choice on the Italian government’s budget. Our way or the lira. Either you let us take control of Italy’s budget, or we take control of our own currency.
The question is when. And the election in Emilia-Romagna, along with the resignation of Five Star’s leader, are two events this week which bring the date much closer.
Conveniently, the EU is set to review the Growth and Stability Pact and the ECB’s governing rules in coming months. In other words, the rules of the eurozone are up for grabs just when having to apply them could force Italy out of the eurozone.
But which way will the rules be changed? To toughen them up, or loosen them?
Last time around the rules got tighter in precisely the way mentioned above — they made ECB bailouts conditional on compliance with EU budget rules.
Either way, as far as markets are concerned, the risk of an Italian meltdown is back. And the Italian bond market has turned the corner as a result:
Italian bank stocks fell and bond yields spiked over the last few days.
Welcome back to 2018’s Italian drama. The canned tomato may be too big to kick down the road this time…
Until next time,
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