Italy's Unspoken Lesson: Tune Out the Political Noise

Editors’ Note: Our political commentary is non-ideological by design. We favor no political party, politician or elected official in any country and assess political developments solely for their potential economic and market impact.

One week ago, Italian co-Deputy Prime Minister Matteo Salvini was flying high after his party, the far-right The League, trounced its competition (and coalition partner Five Star Movement, or M5S) in European Parliamentary elections. In short order, he claimed a new mandate for wide-ranging tax cuts and taunted Brussels over its deficit limits, while his government passed a motion to explore a parallel currency known as the “mini-BOT,” which is a play on the Italian acronym for short-term Treasury bills. Eurozone leaders responded with a letter threatening sanctions if Italy broke its deficit reduction commitments, rekindling fear that the long-awaited Quitaly was at hand. Yet since then, the pendulum has swung in the opposite direction: The Treasury all but disavowed mini-BOTs last Friday, and on Monday, Prime Minister Giuseppe Conte threatened to walk and force a snap election because he couldn’t abide Salvini and M5S leader Luigi Di Maio’s constant bickering. Let this be a lesson in the danger of reacting to short-term fear: The story can flip fast, leaving investors chasing their tails.

What happens next in Italy, we have no idea. After Conte threw down the gauntlet Monday evening, Salvini and Di Maio at first played nice. The Guardian reports they had a cordial phone call and pledged to support Conte and their coalition. But harmony apparently reverted to discord Tuesday, with Salvini reportedly accusing Di Maio of plotting against him and issuing his own ultimatum. They could very well kiss and make up again, or Italy could be heading to a snap election. A lot will probably depend on what the polls show over the next couple of weeks and what party leaders think is in their interest. A politician’s mind is a terrible place to navigate, so we won’t hazard a guess on how this all shakes out.

However the political chips fall, the likely practical outcome is gridlock. Conte’s plea for an end to the squabbling caps a year of Salvini and Di Maio’s escalating rivalry. Their parties may be coalition partners, but their ideological unity is nonexistent. The League is a far-right group that champions limiting immigration, increasing states’ autonomy and restoring economic growth through a two-tier flat tax while jumpstarting demand with infrastructure spending. M5S is a loose grouping of leftists, anti-establishment folks and some who call themselves techno-libertarians. They pushed policies like universal basic income and are quite cool toward the League’s proposals. Their sole unifying force is euroskepticism, and that seems to be fraying fast. The reality of intra-coalition opposition to key legislation has seemingly trumped everything else. By all accounts, The League is now frustrated with the legislative morass, while M5S is tired of playing second-fiddle to their coalition partners.

The mini-BOT saga perhaps shows why. The League’s economic team initially created the proposal, modeling mini-BOTs after the parallel Greek currency former Finance Minister Yanis Varoufakis proposed during the Greek crisis’s apex four years ago. They would be interest-free bonds with a low face value, which the government would use to pay arrears to vendors or tax rebates. Recipients could then use them to pay for government-provided products or services, like (as Reuters explained) gasoline from the state-run oil firm. International observers agree the issuance of mini-BOTs would force the rest of the eurozone to erect capital controls around Italy, forcing it out of the euro overnight—hence the panic after last week’s parliamentary motion. Yet, far from being a greenlight to issue mini-BOTs, it was merely a motion to encourage the Treasury to ponder using mini-BOTs to clear overdue bills. The Treasury has now pondered it and said, no grazie. Or, more fully: “There is no need, and no measures of any type are being considered—certainly not the issue of small denomination state bonds—to tackle any supposed delays in payments by the public administration.” It went on to point out that those supposed delays don’t really exist, and the Treasury has sped up its bill payment in the last two years. In other words, mini-BOTs are a solution in search of a problem and likely to join a long, long list of symbolic motions that never become laws. Sound and fury with little substance, much like the populist coalition itself.

Rather than fret every wrinkle and all the big talk from Europe’s various populist parties, we think investors are best off staying cool and tuning out the noise. Instead, think like markets do, and consider the likelihood of radical legislation. We have a year’s worth of evidence that this coalition can’t pass much, and that was before this week’s epic squabbles. If the government ends up falling and Italy has a snap election, polls suggest a hung parliament remains the likeliest outcome—a recipe for more gridlock. The more ground populists gain, the more consensus splinters, bringing more governments with multiple coalition partners and little to no common ground. It spurs hot rhetoric, but it keeps legislative risk low, reducing uncertainty for investors and businesses. With one less thing to deter risk-taking, this gridlock is generally good for markets.

Fear can weigh on markets in the near term. But over time, the reality of gridlock should bring a pleasant surprise to all those dreading upheaval and Quitaly—an underappreciated bullish point in Italian stocks’ favor, in our view.