Italy towards new elections

• Political uncertainty: On May 27th, the designated Prime Minister Giuseppe Conte gave up his mandate to form a Government. The Italian President acted promptly and gave Prof Carlo Cottarelli, an economist, former IMF representative and responsible for the spending review of Enrico Letta’s Government, the mandate to form an interim government with clear commitments. Yet, this government is unlikely to win a confidence vote in Parliament, given the opposition of 5 Star Movement and League; it will probably therefore be a “caretaker government”, in charge of governing till the next elections, which will take place probably in Autumn or at beginning of 2019 at latest.

• Fixed Income: Investors will continue to ask for a significant uncertainty premium. In the meantime, a short position on Italy is quite costly and this should prevent any strong spread widening. Due to the high uncertainty, we also expect limited spread reduction until the next election. Until the completion of a full budgetary and political integration in the Euro Zone, political risk will remain in investors’ minds. The actions taken by the ECB since 2010-2012 have removed tail risk and the market still believes in the ECB’s ability to manage the situation; otherwise the Euro equity market would not be that resilient.

• Equities: Despite relative cheapness, the Italian market is underperforming due to political uncertainty, as more than 30% of the main Italian index is represented by financials that are domestic players. Italian banks are now stronger than in the past in terms of capital and are in a positive restructuring trend for both cost cutting and reduction in Non-Performing Loans. In the short term, we keep a prudent view, but when there will be more clarity from politics, Italian banks could rebound thanks to their cheap valuation.

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