Add Italy to your global tail risks list as a new fascist government romps home in the polls. TLombard with the note.
Amid the avalanche of political commentary around next Sunday’s near-certain prospect of Italy electing its most right-wing government since WW2, markets will remain focused on the perennial Italy-related systemic risk to the Eurozone. Our reading of the culture and strategy of the incoming coalition points to a ‘game of chicken’ rather than willed confrontation. Under the leadership of Giorgia Meloni–a canny kind of passionaria–they will aim to keep the ball in the court of Brussels and the northern EA ‘frugals’. Beneath the formal manifesto commitment to remain in the Eurozone, the unspoken sub-text is: “let’s see if the Eurozone wants to stay with us”. This seems like a recipe for sharp fear-greed swings in market sentiment, with an effective tactical trading stance being to wait to sell periodic BTP rallies.
To elaborate on this requires starting with one piece of key context: this perennial Italy hazard now comes round in aggravated form even without any political driver from Italy itself. Entering its third decade, the European monetary union is for the first time encountering a serious inflation problem. Resulting increases in the ‘one-size-fits-all’ interest rate may be perceived by markets as jeopardizing the sustainability of Italy’s outsized public debt (now standing at around150% of GDP)–triggering a chain reaction BTP sell-off that makes such concerns a self-fulfilling prophecy. To the extent that pure recession prevails over stagflation in the EA, relieving upward pressure on rates, this would not necessarily dispel public debt sustainability concerns in the case of Italy, given the lack of headroom for counter-cyclical fiscal policy and the recession-driven weakening of banks’ already fragile balance sheets.