SYZ Asset Management comments on the Italian elections

What is your initial reaction to the outcome?

No major reaction in our portfolios since our positioning was already implicitly discounting such risk. We had short future positions on BTPs in our Euro fixed income portfolios (Oyster EURO Fixed Income and Oyster Multi-Asset Absolute Return EUR), we had put option strategies on the equity side of our Defensive Multi Asset Strategies and we had tactically raised the duration profile of our fixed income portfolios last week with long-term “core” European government bonds, on the back of valuations and concerns around slowing short-term growth momentum in the Eurozone.

How do you see it affecting markets, particularly on the fixed income side?

For me the main take-away in terms of investment is the following: the likely hung parliament resulting from the Italian election probably opens a period of uncertainty, something far from unusual in Italian politic. However, this one bears one negative specificity: the two clear winners of the election, Movimento 5 Stelle and Lega, are both euro-sceptic parties. The former is now Italy’s main political party by votes and the later has clearly out-taken the more centrist Forza Italia as the strongest party at the right of the political premium. While the prospect of a coalition between M5S and Lega (clearly the most negative outcome from a market point of view) has a very low probability given how little their platforms have in common, this remote threat and, in any case, their strong political support, makes the prospect of political uncertainty in Italy more unsettling than usual from a market perspective.

It may therefore have a significant and, counterintuitively, positive impact on European fixed income in general. At a time when the ECB is cautiously moving forward on monetary policy normalization and may have been tempted to end its QE program in September, this kind of political uncertainty and risk in the Eurozone’s third largest economy and most indebted public sector might force Draghi & Co to err on the side of cautiousness in order to avoid excessive government spread widening. If QE is to be eventually extended (even only for a few months), it could support European credit and European government rates and spreads, that had been under growing scrutiny especially after last month’s volatility spike.

Therefore, unless the situation evolves into the formation of a truly anti-European government in Italy (a very-low probability event in our view), those elections’ results might finally prove to be supportive for European fixed income assets, with only Italian bonds possibly experiencing risk premium increases.

Has it affected your stance at all?

Not really as we already had tactically moved last week into a more constructive view on European fixed income while keeping specific protections on Italian rates.

Do you think investors are getting spooked by the outcome?

“Spook” may be excessive but the price actions of the past few weeks suggest that investors were not worried of the specific Italian risk, maybe expecting the vote to ultimately bring a Euro-friendly Center right coalition led by Forza Italia. As such rosy scenario has not materialized, this might lead to some repricing of the Italian risk across the board, especially on the government spread side, a force that we expect the ECB to try to lean against.

Adrien Pichoud – chief economist – SYZ Asset Management