Market Takes Italian Political Turmoil in Stride
The Italian 10-year premium over Germany (white line) has generally fallen over the past year as the dollar against the euro (yellow line).
Of course, as one would expect the euro is more volatile than the 10-year interest rate spread. Sometimes there is a better fit than at other times. And the dollar has recovered a bit against the euro at the start of the year, even though the Italian premium has little changed.
The big news today is not simply that Italian Prime Minister Letta been forced to resign as the PD withdrew its support, but that this has not sparked convulsions in the capital markets. Indeed the Italian 10-year bond recovered from early weakness to close higher on the day, with the yield falling 2 bp, a single basis point less than the yield decline in Spain. Moreover, at the shorter end of the curve, the Italian 2-year yield fell 2 bp, while Spain’s yield fell a single basis point. On the equity side, Italian shares did finish marginally lower (-0.17%), which was in line with the Dow Jones Stoxx 600.
There is a certain degree of, dare one say, euphoria about Letta’s successor Renzi. Many investors and observers have been frustrated with the lack of progress in Italy on a number of different fronts. The economy remains one of the weaker ones in the euro area. It external position has not improved nearly as much as Spain’s. Unit labor costs remain high. Italian banks have lagged behind most other countries in returning LTRO funds. Yet when one prods a bit deeper, it seems that more is involved than personalities.
Monti was a reformer. Letta was committed to reforms as well. Why is the knee jerk reaction that Renzi will succeed where Monti and Letta failed ? One large Italian bank said Renzi would expedite reforms and do so without a resort to early elections, which is “good news”. Other observers have played up the fact that Renzi is relatively youthful at 39 years old.
Letta is 47, which is also young for Italian politics. The US and UK have relatively young heads of state. So what ? It does not necessarily represent a generational transfer. Surely, such a phenomenon is not decided by one election, but several. Besides, ultimately, age may be a nice cosmetic issue, but political ideology and ability to implement a visionary program is more significant.
Renzi offers a different personality, but not a different agenda. Renzi is not a member of parliament. He is a mayor. He has little experience on the national, let along international stage. By being the third unelected prime minister, he will add to Italy’s democratic deficit. His declaratory policy is opposed to back room deals and subterfuge, but he has done exactly that. Rather than seek allies among his center left coalition for electoral reform, he sacrificed them and their interests to join forces with Berlusconi and the PdL. He had previously indicated he would allow Letta to fulfill his 18 month agenda, but he pulled the plug formally today after undermining him in recent weeks.
Renzi has marred his own gravitas. He appears to be an ambitious and impatient young man. He may have won the battle, but may very well lose the war. First, he is likely to be the PM and be held responsible for the half hearted economic recovery. Second, he is likely to be the PM come the May EU parliamentary elections that will likely see a big push back against the EU and the political elites, of which Renzi needs to be count among. Third, is own ability to govern will be hampered as was Monti and Letta’s by the rigidity of Italian institutions and an incentive structure that rewards rent seekers.
It is likely that after the electoral reforms are passed, that elections will be held late this year or early next year. Renzi’s back-door ascension to the premiership will leave a bad taste and failure to reanimate the Italian economy and polis will leave him vulnerable to a electoral victory of the center-right. The party discipline and culture means that many will initially take the stance of “the king is dead, long live the king”. The risk is that they are fickle and turn on him later.
Moody’s has signaled that it along with Lativa, it will focus on Italy this week. It is unlikely to cut Italy’s rating, when the conclusion of the review is announced tomorrow. which is has at Baa2 with a negative outlook. While the inclusiveness of last February’s election was cited a credit negative, over the past year, Italian interest rates have fallen sharply and the pressure for international assistance has ebbed.