GOLDMAN: There's Almost A 50% Chance Of A Negative Outcome In Italy

silvio berlusconi

Photo: Joseph Weisenthal, Business Insider

Reminder: The first exit polls from the Italian election will hit some time around 9 AM ET on Monday, before US markets officially open.The hope for World markets/the EU/Italian elites is that the centre-left parties get enough votes to form a stable majority.

The fear is that there will be a big surge for the conservative (Berlusconi) and populist (Beppe Grillo) movements, making a government untenable, and thus risking a backsliding of Italy’s reforms, causing borrowing costs to jump, and thus reigniting the European crisis. Italy is Europe’s largest debt market, and the third largest in the world.

According to Goldman, it could go either way:

On what is seen as the most likely result – a centre-left coalition government – the 10-yr yield spread to Germany could narrow by 50-75bp from current levels. But an outcome deemed almost as probable – a ‘hung parliament’ – could lead to market volatility while an agreement among parliamentary groups is sought. From a strategy standpoint, we reiterate our constructive stance on the direction of EMU spreads, but maintain a preference for Spain over Italy.

If the parliament is hung, says Goldman:

An outcome seen as almost as probable, however, is one of no clear majority resulting from the vote. In case of a relatively strong showing by either Mr. Berlusconi or Mr. Grillo’s movement, the coalitions headed by Mr. Bersani and Mr. Monti would not get enough seats to control the Upper House and form a government.  In such scenario we foresee two alternatives:     

  • ‘Government of National Unity’: Facing the prospect of political instability and subject to international political and market pressures, President Napolitano could encourage the formation of a government of national unity on the basis of a specific and pre-agreed agenda, which would include a new electoral law. This solution would probably attract the support of moderate actors across the political spectrum and, possibly, of Mr Grillo. The resulting transitional government could be headed again by Mr. Monti, but would be highly unstable and with a short term mandate (between 1-2-years). 

Markets would be very nervous until an agreement is hammered out. Consequently, we would expect a sharp increase in volatility during this period, with spreads widening in a two-way flows market. As it becomes clearer that a new government would be formed, BTPs could stabilise around current levels – i.e., wider than implied by macro factors especially at longer maturities.

  •  Fresh General Elections Are Called: This is generally deemed as a much more remote outcome because it appears fruitless to call for new elections under the current electoral law. The decision rests with President Napolitano, who has the power to dissolve one or both Houses. 

From a markets perspective, this outcome would magnify volatility, and BTPs would come under considerable pressure. Bond spreads as wide as those seen in November 2011 (550bp over Germany in the 10-yr area) are not unreasonable as a working hypothesis. Under this scenario a caretaker government could ask the Eurogroup and the ECB for help under the OMT framework.

Goldman also leaves the door open to a possible victory outright by Silvio Berlusconi, which would potentially be very unwelcome news.

One note so far: Turnout is down from the last election in 2008.

This is a bit of a surprise, and it could be ominous for the cause of stability. It could mean that the mainstream centre-left parties (which seem to inspire very little passion in anyone) are seeing their supporters stay home, while the protest parties (especially Beppe Grillo’s 5-star movement) are surging. That’s just one possibility. The weather is also bad in a lot of the country. Some older voters might just be sitting it out.

We’ll know more in a few hours.

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