“Traditional parties however, are in a position of weakness, and will have to strike a deal with the M5S [Five Star Movement] or the Lega [Northern League]. More importantly, even though the Lega and the M5S will have a greater say in the political agenda, the more extreme views from either party are likely to be tamed somewhat once they get into power,” Ferrarese said.
“Their anti-European rhetoric is already much softer than it was in the past, although they will place greater focus on fiscal easing, and a more confrontational attitude towards European partners.”
However, Ferrarese noted that the initial market reaction was “not a lot” and the Italian government bonds (BTPs) were only a few basis points wider – meaning the market was not surprised by the outcome.
“A coalition was considered a good outcome but the market preference was for one involving mainly the traditional parties. Now, however, it looks increasingly unlikely that populist parties, and the M5S in particular, can be left out of a broad coalition given the election result,” he said.
“Going forward the exact market reaction would depend on how diluted M5S would be in such a coalition — the softer their stance will become, as they negotiate with other parties, the better for BTPs at least initially. The market doesn’t like uncertainty, so it makes sense that the initial reaction might be a cold one until the fiscal path taken by the new government is better known.”
Fiscal spending and anti-Europe concerns
NN Investment Partners head of multi-asset, Ewout van Schaick, said given the strong gains by the populist parties, he expected some weakness in main Italian stocks and BTPs in the short term, but no impact on wider European or global markets.
Columbia Threadneedle Investment’s head of global rates and currency, Adrian Hilton, said the reaction of bond markets had been fairly restrained and that the most negative outcome of the election would a coalition comprising of the populist parties, Lega and Five Star Movement.
“Such a scenario would probably worsen relations with the European Commission, especially around fiscal targets. But we are a long way from Italy ditching the euro – both anti-establishment parties have toned down their euro-scepticism in recent months and surveys continue to show a popular majority in favour of membership of the single currency,” Hilton said.
He noted that a euro break-up risk was at its lowest for years.
While Franklin Templeton Investments head of European fixed income, David Zahn, is still optimistic on Italy’s long term fundamentals, he said the potential push for increased fiscal spending from the populist parties remained a concern.
“We significantly reduced our weighting in Italy in our Franklin European Total Return fund ahead of the election, as we anticipated some political volatility to arise,” he said.
“We are in wait-and-see mode on Italy at the moment, and will likely look to see how the political situation pans out over the coming weeks before reassessing our positioning.”