Lessons From Italy’s Latest Political Drama

Editors’ note: Our political commentary is intentionally non-partisan. We favor no politician nor any political party globally and assess political developments solely for their potential economic and market impact.

In all of last year’s chaos and mayhem, one thing was noticeably absent: Italian political theatrics. But it is absent no more, as former Prime Minister Matteo Renzi pulled his upstart Italia Viva party from the governing coalition Wednesday, threatening its survival. We don’t think this is a terribly momentous event for Italian stocks, which are very, very familiar with unstable governments. Long-term interest rates don’t seem bothered either. But the story does highlight the degree of gridlock entrenched in Italy—keeping legislative uncertainty low even as political squabbling spikes—and holds a key lesson for investors fearing radical legislation in the US.

The now-splintering coalition has been in place since late-2019, when Matteo Salvini, leader of the nationalist party known as The League, pulled his party from a coalition with the anti-establishment Five Star Movement (M5S). At the time, Salvini was fresh off a much-photographed beach tour (those were a thing then) and riding a wave of popularity (pun intended). He sought to capitalize by forcing snap elections, thinking he may win an outright majority, eliminating the need to coalesce with a party that wasn’t very aligned with his. But Renzi, then influential with the center-left Democratic Party (PD), opened coalition talks with M5S, and they eventually yielded a left-leaning multiparty coalition. Shortly after that, Renzi and some of his supporters left the PD and formed the small, centrist Italia Viva, which remained part of the coalition. But pandemic-related squabbling nibbled away at the parties’ unity, and a disagreement on how to spend €36 billion of EU aid prompted Renzi’s exit.

What comes next isn’t clear. Giuseppe Conte remains prime minister, and he could try to preserve the coalition with a cabinet reshuffle and a confidence vote in a minority government. Or he could resign, get a fresh request from President Sergio Mattarella to form a new government, and try again from scratch. Or, Italy could hold a snap election, potentially paving the way for Salvini and The League to re-enter the government. However it plays out, though, the reality of a very gridlocked, internally fractured Italian government probably won’t change. That may further delay economic reforms, but it also makes radical leftist or nationalist change unlikely, and markets have already shown their comfort with the gridlocked status quo. Italian 10-year yields, which are quite good at revealing debt jitters, don’t seem bothered—they’re at 0.64%, well below the US.^[i] That is a 0.05 percentage point gain from yesterday, but to a level that is at the low end of the range yields have traded in over the last year.

In our view, this saga’s primary significance is what it symbolizes. For years, investors have feared M5S would not only find a way to undo the precious few reforms Italy managed to pass during the 2010 – 2013 debt crisis, but would make economic policy even less competitive than it was before then. But that didn’t happen—too much gridlock. Quite simply, a government that can’t even agree on how to spend €36 billion in “free” money is also a government that can’t add public sector bloat, make labor laws unnavigable or anything else investors have feared for years. (Much less exit the euro!) Let that be a lesson: Even when one extreme party enters government, the gridlock that comes with a multiparty coalition forces moderation. Keep that in mind as other European nations go to the polls this year.

Keep it in mind, too, as you watch the US Congress this year. No, the US doesn’t have a raucous multiparty system like most European nations. But the two major US parties each have their own factions and disagreements internally. A certain Democratic Congresswoman from Queens has even said as much, pointing out that if the US were in Europe, she and her like-minded squad wouldn’t even be in the same party as their more centrist colleagues. But whether or not they are all under the same umbrella, the reality of disagreements between self-styled progressives and more moderate lawmakers reigns. It is largely the same within the Republican Party. Factional disagreement promotes gridlock just as much as squabbling among small parties across the pond. Combine that internal splintering with the tiniest majority in modern history, and it is a recipe for very, very little getting done. Whatever your personal feelings about that, it means stocks don’t have to grapple with a high likelihood of major change, and that relative lack of uncertainty is a positive.