Trading on the Italian referendum

On December 4th, Italians head to the polls for what could be another major market-moving event. They are voting on constitutional reforms but the plebiscite has turned into a wider vote on the government, the ailing Italian economy and the very future of the country’s place at the heart of Europe.

Italy-banks-European-banks

What it’s about

 

The vote covers significant reforms to the legislature that are collectively are designed to make it easier for the government to pass new laws. The key change would see the upper house (Senate) reduced to 100 members from 315. These would no longer be directly elected but enter the chamber by virtue of some other elected office – councillors, mayors and presidential nominees will comprise the new Senate. The other eye-catching change would mean the lower house (House of Deputies) could pass laws without approval by the Senate.

Effectively it would centralise power in the hands of the lower house and give Renzi a free hand to enact the kind of pro-business, pro-growth reforms he wants.

What the polls say

 

The latest polling data ahead of a two-week blackout, during which publication of polls is prohibited before the vote, showed a healthy lead for the ‘No’ camp, although many Italians seem to be undecided.

Demos & Pi for newspaper La Repubblica – Yes:34%, No:41%

Istituto Piepoli for La Stampa – Yes:46%, No:54%

Ipsos for Corriere della Sera – Yes:45%, No:55%

Ixe for Agora-Rai3 television - Yes:37%, No:42%

On November 28th, ETX’s Italian Referendum market gave the Yes side a roughly one-in-three likelihood of winning.

Why it matters

 

Renzi made this personal by saying he would probably resign if he loses. That has helped to turn this into a straight vote of confidence in the government and for many Italians the prime minister embodies the establishment elite that they want to kick.

The problem is that the economy is not working. Unemployment is high at more than 11% and government debt to GDP is running at 133%. Unlike the UK, US and Germany, growth has resolutely failed to materialise since the financial crisis. Productivity has collapsed over the last 15 years.

If Renzi does resign we could see political turmoil roil markets and fresh elections that could strengthen the position of populist parties opposed to the centre-left regime.

Italy’s continued involvement in the Eurozone may be cast into doubt if Renzi loses. The three main opposition parties - The Five Star Movement, Lega Nord and Forza Italia all want to leave the euro behind. If Renzi resigns it could put pressure on the government to call fresh elections and the position of the ruling elite looks shaky in what has become the year of populism.

If Renzi doesn’t resign, the centre left will be left as a lame duck government until scheduled elections in 2018, leaving little real hope of meaningful reforms to get Italy’s economy moving again.

Moreover, fresh off the back of the populist surge in the UK and US, a ‘No’ vote could provide further succour to anti-establishment, anti-EU parties ahead of French and German elections next year.

Which markets are affected


Euro

The euro has already suffered at the hands of the mighty dollar. EURUSD has been crushed since Donald Trump won the US presidential election and the next stop lower is parity. A ‘No’ vote and Renzi resignation could spook currency markets, which would have to start to price in the risk that the Eurozone could lose its third-largest economy.

EURUSD_NOv28

EURUSD has shed about 5 cents since Trump’s win, sliding from around the 1.11 handle to bounce around the 1.06 level. The euro has firm support around 1.05 but this could face a serious test should Italy vote against the reforms.

Bonds

The referendum comes just a week before two key central bank meetings. The European Central Bank (ECB) convenes on December 8th, while the Federal Reserve is due to make its monetary policy statement on December 14th.

Markets are currently pricing in a 100% chance the Fed will hike rates, while the ECB may be forced to react to an Italian referendum result could  send bond markets into a spin. The bank is widely expected to extend the duration of its bond-buying programme. Italian bond yields have doubled since August as investors fret over the outcome of the referendum.

Yields are of course rising across the market, but the risk premium for Italy is greater than its European peers. The spread between the yield on Italian government debt and Spanish bonds has widened significantly. Yields on Italian 10-year paper has stretched from approximately 1% to 2% since August, while that for Spain has only increased about half that much, from approximately 0.9% to 1.5%.

Banking stocks

The immediate market stress could show in Italy’s embattled banks.

Italy’s banking sector is creaking under the weight of bad loans. Lenders are saddled with about €400bn in non-performing loans, which amounts to about a third of all the Eurozone’s bad debt and about a fifth of all consumer loans in Italy.

Italian banking stocks have taken a battering this year (percentage stock decline over last 12 months):

Banca Monte dei Paschi di Siena (BMPS) -88%

Banca Popolare dell’Emilia Romagna (BPE) -50%

Banca Popolare di Milano (PMI) -69%

FinecoBank (FBK) -35%

Intesa Sanpaolo (ISP) -39%

MedioBanca (MB) -33%

UBI Banca (UBI) -69%

UniCredit (UCG) -66%

The bank most in the spotlight is Banca Monte dei Paschi di Siena, which has embarked on an ambitious capital-raising plan after several false starts this year. It has to muster €5bn in fresh capital and shed €28bn in bad debt before the year end. A ‘No’ vote could see the recapitalisation flop and creditors would almost certainly have to take losses.

The worry is that contagion at BMPS will spread through the banking sector. Of critical concern is that UniCredit’s €13bn capital increase, slated for 2017, could be on the line if BMPS cannot get its house in order. UniCredit is Italy's only globally systemically important bank.

UniCredit_Nov28

Italy’s banks are suffering under a weight of bad loans but the real drag is the under-performing Italian economy, whose lacklustre performance means challenging market conditions are compounded by weak domestic prospects.

Moreover, DBRS, which is the only ratings agency that lets Italian banks enjoy cheap funding, has placed Italy on negative credit watch. A loss in the referendum could easily see Italy’s credit rating cut, which would force Italian banks to hold more collateral to borrow from the ECB.

Contagion risk is not confined to Italy. Several of Europe’s biggest lenders may also suffer if fears about solvency spread.

From Germany to Portugal, Europe’s banking sector looks shaky. Only this week resignations at Caixa Geral de Depositos rocked confidence in the Portugal’s state-owned back ahead of a €5bn rescue package. Fears about Deutsche Bank persist and would likely not be helped by the threat of failure of any major Italian banks.

Margin Changes

 

From December 2nd, margins on the following markets will change temporarily to the rates displayed below to reflect the expected heightened volatility.

Italy_Ref_Margins

Margins represent the lowest available margins and are subject to tiering.

These will apply to all open positions. Please ensure you have enough funds on your account at all times in order to maintain your open positions.

Finally, to better protect our clients from severe market stress, we will require traders to maintain 100%  margin in their accounts at all times  or  they  run  the  risk  of  positions  being  closed  out  at  any  time.  Losses  may  still  exceed  deposits  but  this  measure  is  aimed  at reducing the chances of this happening.

Increased volatility means increased opportunity but also increased risk. The changes set out above are designed to help reduce the potential exposure to severe market movements, however all trading involves risk and losses may still exceed deposits.

If you have any questions  about  how  these  changes  will  affect  you,  please  contact  our  customer  service  team  on +44  (0)  20  7392  1494,  or  by  email  at customer.service@etxcapital.com.

 

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