In addition to the recent note by Credit Suisse, here, courtesy of a note by UBS’ Felix Huefner, is what you need to know about the upcoming Italian referendum – an event that has been dubbed by some as the most important risk event for Europe in the remainder of the year – scheduled for December 4.
Referendum is about political uncertainty and reform progress
An important forthcoming event is the Italian referendum on constitutional reform, which is scheduled for 4 December. Based on recent opinion polls, the outcome is too close to call. This referendum is important for at least two reasons. First, political uncertainty is affected, as the outcome of the referendum is perceived to impact Prime Minister Renzi’s decision whether to remain in office (despite recent attempts to de-link the content of the referendum from his decision whether to stay in power). This seems to be the key market focus currently. Second, constitutional reform is an important element of the government’s reform agenda. Along with past reforms, such as the one on the labour market, continuing reform is likely positive for the longer-term growth outlook. Possible scenarios for the referendum include: (1) if the referendum is voted down, political uncertainty increases and reform progress takes a step back; (2) if voted in favour, political uncertainty decreases and the reform agenda progresses, potentially including steps to overhaul the judicial system. This double impact arguably increases the importance of the Italian referendum for the outlook.
Implications for Italian government bonds
The associated implications of a ‘No’ vote continue to present a risk to Italian bond spreads. Our expectation of core euro area yields rising gradually over the next few months (supported by upcoming base effects and potential tweaks to the ECB’s QE programme), combined with the fact that the 10yr Italy-Germany spread is close to our year-end target of 125bp, implies a gradual rise in 10yr Italian yields to 1.45% by end- 2016. If a ‘Yes’ vote were to materialise, we would expect 10yr Italy-Germany spreads to initially tighten by 5-10bp. Meanwhile, a ‘No’ vote at the upcoming referendum is likely to result in 10yr Italy-Germany spreads widening to over 155bp. The political backdrop in Spain is currently more favourable than in Italy, and we maintain our preference of being long 10yr Spain versus Italy. We also recommend hedging against a potential escalation of Italian risks by selling 10yr Italy vs US Treasuries (targeting 0bp).
The actual constitutional reform
The constitutional reform that is voted on in the referendum is part of a package aimed at making the political system more stable and facilitating decision-making. The package includes: (1) the electoral reform (Italicum); and (2) reform of the Senate. The first entered into effect earlier this year (but is currently challenged and awaits a decision by the Constitutional Court), while the Senate reform is being decided on 4 December in a referendum.
In broad terms, the Italicum legislative electoral reform replaced proportional representation in the lower house (Chamber of Deputies) with a majority-assuring voting system that attributes a majority bonus to the party (no coalition) with the highest share of votes. The intention is to make the government majority more stable and homogenous. The law came into force in July 2016 (and the next elections in 2018 would be the first held under the new rules). However, the Italicum is viewed controversially and is under review by the constitutional court.
The upcoming December constitutional referendum is about transforming the Senate of the Republic (the upper house) into a Senate of the Regions (a referendum being necessary because the reform failed to achieve a two-thirds majority in parliament). Currently, both the lower house (Chamber of Deputies) and the Senate are elected simultaneously, the government needs the confidence of both houses, and all legislation is passed by both houses. Under this ‘perfect bicameralism’, both chambers thus have equal powers, complicating decisionmaking. Under the reform, the number of senators will be reduced from 314 directly elected to 95 indirectly elected (by the regional councils of Italy) and the participation of the Senate in the law-making procedure will be reduced. Constitutional reform is thus seen by the IMF and the OECD as a key part of the reform agenda to streamline decision-making, along with further implementation of the Jobs Act labour market reform.
The political uncertainty surrounding the referendum outcome
When the referendum was first announced, Prime Minister Renzi specifically noted that, in case of defeat, he would step down as Italian Prime Minister, opening up the possibility of new elections. Over the past few weeks, the perception has been that he has adjusted his position on this matter, stressing that the next general election would be held in spring of 2018 (as originally planned). Another scenario could thus be that PM Renzi remains in power even in the case of a defeat. Yet another alternative scenario could foresee Prime Minister Renzi stepping down and a new PM being appointed without new elections. Either way, a defeat in the referendum would likely heighten policy uncertainty, not least because the 5-Star Movement has become a main challenger to Renzi’s PD in recent opinion polls, notably after the UK referendum.
New elections right after a ‘No’ vote look less likely, given that the new electoral law (Italicum) applies only to the lower house (Chamber of Deputies) – it was passed in the expectation that the reform of the Senate would proceed. Any government after a ‘No’ vote will thus likely be occupied with adapting the respective electoral laws for the next election.
Implications of a ‘No’ vote a risk to Italian bond spreads
Opinion polling ahead of the constitutional referendum remains finely balanced and the associated implications of a ‘No’ vote continue to present a risk to Italian bond spreads. Our expectation of core euro area yields rising gradually over the next few months (supported by upcoming base effects and potential tweaks to the ECB’s QE programme), combined with the fact that the 10yr Italy-Germany spread is close to our year-end target of 125bp, implies a gradual rise in 10yr Italian yields to 1.45% by end-2016. If a ‘Yes’ vote were to materialise, we would expect 10yr Italy-Germany spreads to initially tighten by 5-10bp. Meanwhile, a ‘No’ vote at the upcoming referendum is likely to result in 10yr Italy-Germany spreads widening to over 155bp. The political backdrop in Spain is currently more favourable than in Italy, and we maintain our preference of being long 10yr Spain versus Italy. We also recommend hedging against a potential escalation of Italian risks by selling 10yr Italy versus US Treasuries (targeting 0bp).
The post The Italian Referendum: What You Need To Know appeared first on crude-oil.top.