Italy's Coalition Is Kaput

Welp, it is official: Italy no longer has a government. With a no-confidence vote—tabled by the junior coalition partner—looming over Prime Minister Giuseppe Conte, he resigned Tuesday, ending the alliance between the anti-establishment Five Star Movement (M5S) and nationalist League. League leader Matteo Salvini called for the no-confidence vote over a week ago, but lawmakers delayed it in an effort to buy time for alternative alliances to gel. In the coming days, we will find out whether they were successful—or whether the country will hold new elections, perhaps as soon as October. So for now, political uncertainty rules. Longer term, however, the likelihood of an Italian government—regardless of who leads it—passing major, market-disrupting change appears low.

By all accounts, Salvini pulled the plug on his own government because he wants new elections. While the League currently has 91 fewer seats in the lower house than M5S, its poll numbers have soared. 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. M5S is down to 19%, and the PD has 23%.^[i] Strike while the iron is hot appears to be Salvini’s strategy.

But he doesn’t have the say-so over new elections. That power rests with President Sergio Mattarella. Whether he calls them will likely depend on whether M5S and the center-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, good enough for a small majority. Unlike M5S and the League, they are sort of aligned ideologically. But until last week, they were also bitter rivals. Their rapprochement is mostly a (potential) marriage of convenience to keep Salvini from getting his way. That was enough to get them to join forces to block his no-confidence vote when he first submitted it last week, but whether it gets them to agree on a governing program is another matter entirely.

Complicating matters, there are internal divisions within the PD. Former Prime Minister Matteo Renzi still holds significant influence and is, to many, the face of the party. He happens to be the one pushing for an alliance with M5S. But the PD’s actual leader is Nicola Zingaretti, and he is not 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 all-hands-on-deck meeting that included M5S’s founder, comedian Beppe Grillo, he softened his stance somewhat. Once again,  the maxim that politicians’ opinions are pliable when the opportunity to gain power arises seemingly holds. Maybe that softening sticks, though with some speculating Renzi is using this situation to regain party leadership, it is anyone’s guess how Zingaretti will decide to act.

Ultimately, this probably goes one of two ways: 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. An alliance between M5S and the PD would have 14 fewer seats than the outgoing coalition, which hardly passed anything. While M5S and PD have more in common than M5S and the League, Renzi is presently hyper-focused on Italy’s deficit and staying out of Brussels’ disciplinary proceedings. If that viewpoint holds, the PD would probably be a handbrake on M5S’s more radical spending proposals (e.g., universal basic income and reduced retirement age). As for a League-led coalition of right-leaning parties, this inspires abundant fear because of Salvini’s rhetoric, but the League’s economic proposals were always more market-friendly. 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 be awfully tight, so we would discourage high hopes.

Regardless of who takes power, therefore, gridlock probably continues—a fine outcome for markets. Tax reform would be nice, but Italian markets don’t need it—the notion that markets need catalysts like that is usually well wide of the mark. Moreover, markets generally dislike active governments, because a government with a big majority is equally capable of passing harmful legislation as beneficial. That is true, in our view, regardless of said government’s ideological leanings. Moreover, with debt the primary fear surrounding Italy right now, the likelihood that any government could come in and drive deficits through the roof is quite low. Everyone thought the M5S/League government would bring a debt crisis—they didn’t. Gridlock prevailed and probably keeps doing so.

Therefore, if uncertainty rattles Italian and European stocks 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. Gridlock should neuter anything radical, bringing investors some welcome relief.