Italy’s Coalition Is Kaput

On Tuesday, Italy’s government collapsed when Prime Minister Giuseppe Conte resigned ahead of a looming no-confidence vote, ending the alliance between the anti-establishment Five Star Movement (M5S) and nationalist League. League leader Matteo Salvini called for the no-confidence vote 8 August, but opposition lawmakers delayed it in an effort to buy time to explore alternative alliances. In the coming days, we will likely find out whether they were successful—or whether the country will hold new elections, perhaps as soon as October. So for now, we think political uncertainty likely lingers. Longer term, however, the likelihood of an Italian government—regardless of who leads it—passing major, market-disrupting change appears low, in our view.

According to the coverage in news outlets we follow, Salvini triggered his own government’s fall because he wants new elections. Whilst the League currently has 91 fewer seats in the lower house than M5S, its poll numbers have soared since last year’s election. The latest poll averages give the League 36% and its would-be coalition partners, Silvio Berlusconi’s Forza Italia and the far-right Brothers of Italy, 6% and 7%, respectively.^[i] M5S is down to 19%, and the PD has 23%.^[ii] Striking whilst the iron is hot appears to be Salvini’s strategy.

But Salvini doesn’t get to call new elections. That power rests with President Sergio Mattarella. Whether he calls them will likely depend on whether M5S and the centre-left Democratic Party (PD) can form a stable government and convince Mattarella of their staying power. This isn’t outside the realm of possibility. Together, they have 327 seats in the 630-seat lower house, enough for a small majority. Unlike M5S and the League, they look like they are more ideologically aligned. But until last week, they had a public record as bitter rivals. Their potential rapprochement—if consummated—would probably be a marriage of convenience to keep Salvini from getting his way. That was apparently enough to get them to join forces to block his no-confidence vote when he first submitted it two weeks ago, but whether it gets them to agree on a governing programme is likely another matter.

Complicating matters, there are seemingly internal divisions within the PD. Former Prime Minister Matteo Renzi still appears to hold significant influence and, to many, looks like the face of the party. Most political news coverage portrays him as the one pushing for an alliance with M5S. But the PD’s official leader is Nicola Zingaretti, and news reports imply he isn’t quite so warm to the idea of a coalition. When Renzi launched the cross-party talks last week, Zingaretti denounced the effort. Yet on Monday, following a weekend meeting that included M5S’s founder, comedian Beppe Grillo, he appeared to soften his stance somewhat. Maybe that softening sticks, though with some pundits speculating Renzi is using this situation to regain party leadership, we think it is anyone’s guess how Zingaretti will decide to act.

Ultimately, this probably goes one of two ways, in our view: Italy gets a left-leaning coalition in the near term, without new elections, or a right-leaning coalition after new elections. We suspect markets shouldn’t mind either. A prospective alliance between M5S and the PD would have 14 fewer seats on paper than the outgoing coalition, which had few legislative achievements. Whilst M5S and PD likely have more in common ideologically than M5S and the League, Renzi seems hyper-focused on Italy’s deficit and staying out of Brussels’ disciplinary proceedings. If that viewpoint holds, the PD would probably be a brake on M5S’s more radical-sounding spending proposals (e.g., universal basic income and reduced retirement age). As for a League-led coalition of right-leaning parties, this seems to inspire abundant fear amongst many financial publications we follow because of Salvini’s nationalist rhetoric, but the League’s economic proposals appear more market-friendly on their face, in our view. Tax reform, for one, could be a long-term positive if executed well. At the same time, current polls suggest this coalition’s majority would likely be very tight, so we would discourage high hopes.

Regardless of who takes power, therefore, gridlock probably continues—a fine outcome for markets, in our view. Whilst we think tax reform would be beneficial, Italian markets likely don’t need it—the notion that markets need catalysts like that is usually well wide of the mark, according to our research. Moreover, in our experience, markets generally dislike active governments, because a government with a big majority is equally capable of passing legislation negatively affecting markets as positively affecting them. That is true, in our historical analysis, regardless of government’s ideological leanings. Moreover, with sovereign debt seemingly the primary fear surrounding Italy right now, the likelihood that any government could come in and drive deficits through the roof appears quite low. Many pundits we read thought the M5S/League government would bring a debt crisis—but they didn’t. Gridlock prevailed, in our view, and it probably keeps doing so.

Therefore, if uncertainty rattles Italian and European markets in the coming days and weeks, we would encourage investors to see through it and tune out political rhetoric—especially if that rhetoric comes from wild campaign trail proposals. We think gridlock should neuter anything radical, likely bringing investors some welcome relief.