On Sunday 4 December Italians will vote in a constitutional reform referendum, which
includes provisions to transform the Senate into a smaller “chamber of
regions” and a redefinition of competencies shared by the central
government and regional authorities. The vote requires a simple majority
and has no quorum requirement. Markets have priced in risk premium
around the date of the vote, as shown in Figures 6 and 7 – increasingly
so since the US election. The front end of the EURUSD implied vol curve
has rallied sharply, and appears elevated relative to the G10 average
National opinion polls show that the ‘no’ vote has been gaining ground in the weeks leading up to the vote. Markets’
expectations on the directional outcome of the vote are somewhat
consistent. The EURUSD risk reversal skew has moved back to being in
favor of EUR puts over calls, following the brief post-US election
spike, but is far from the extreme levels seen earlier this year after
the Brexit referendum, or during the Euro crisis of 2011-12 (Figure 8).
Furthermore, Italian yields have widened against the German benchmark,
but also and most notably against Spanish yields, a country that shares
many of Italy’s low growth and high unemployment ailments (Figure 9).
In other words, markets view the referendum as important (as
per the kink in the vol curve), somewhat biased in favor of a negative
outcome (as suggested by the riskie), but idiosyncratic to Italy (as
implied by spreads). The part where we tend to disagree with the
market’s assessment is the latter. A win of the ‘no’ vote would likely
be viewed in markets as detrimental to Italy’s political stability.
While this would not be news per se given the country’s tattered history
of frequent government turnover, it comes at a challenging time for
Italy’s banking system, with several financial institutions struggling
publicly with growing NPL portfolios and heightened market focus on the
A victory of the ‘no’ vote would likely have a EUR negative outcome, in our view .
It would not necessarily cause the Renzi government to fall, but it
would likely cause fears of such an outcome to grow rapidly, especially
in the light of the strong performance of the anti-euro 5-Star Movement
party in local elections in June of this year and with an eye on
national elections in Germany and France in 2017 (potential
repercussions from the Italian vote on next year’s electoral
consultations in the two largest countries in the euro area alone argue
against an idiosyncratic interpretation of the referendum results).
Furthermore, given the focus on the local banking industry’s near-term
funding needs, widening credit spreads would amount to a tightening in
financial conditions, which could amongst other, trigger expectations of
a response by the ECB in the form of a more accommodative monetary
‘yes’ vote, on the other hand, would likely give way to a positive knee
jerk reaction in EURUSD, but is unlikely to drive a lasting rebound in
the currency, given political risks looming in France
and Germany 2017, the prospects of monetary policy divergence and the
still unclear outcome of Brexit negotiations.
As technical-based trades, CS maintains 2 limit order to sell EUR/USD at 1.0730, and at 1.1025.
Italian constitutional referendum would not have caught the world’s
attention had the Prime Minister Matteo Renzi not made it about himself.
This opens a myriad of options, which is covered in detail by the analysts’ at Nomura.
Risk to the markets if the Five Start movement comes to power
main risk is if the M5S holds a referendum similar to the Brexit.
Though it is not certain that they would do so, but the markets will
invariably price in the risk to such an event.
Italy is finally holding its referendum on constitutional reforms.
Prime Minister Matteo Renzi's proposals would reduce the powers and
size of the Senate, granting the Chamber of Deputies more authority and
transferring prerogatives from regional administrations to the central
government in Rome. The changes would, in theory, sever the link between
political instability and financial fragility in Italy. Instead,
because Renzi has promised to step down if the Italian people vote
against the reforms, opposition parties such as the Five Star Movement
and the Northern League — and even some members of Renzi's center-left
Democratic Party — have cast the referendum as a chance to force the
prime minister and his government to resign.
Even if voters reject the reforms and Renzi resigns, early elections
for a new government are not a given. Italian President Sergio
Mattarella could ask Parliament to form a new government and appoint a
prime minister, probably with the goal of introducing political and
economic reforms. The Five Star Movement has said it would not support a
caretaker government, but the Democratic Party and its junior coalition
partner still control enough seats in Parliament to appoint a new prime
minister, provided that they stay united.
Moreover, opinion polls show that the Five Star Movement's popularity
is close to that of the Democratic Party, giving it incentive to avoid
early elections that could unseat it. In a potential runoff election
between the Democratic Party and the Five Star Movement, all opposition
parties could side with the protest party to propel it to victory. This
prospect might impel the government to change the rules while it still
can. Lorenzo Guerini, the deputy secretary of the Democratic Party, has
said that in case of a defeat in the referendum, the party would try to
modify the country's electoral laws so that new elections could be held
in summer 2017.
Whether or not the referendum fails and subsequent early elections
are held, the possibility that the Five Star Movement will eventually
triumph at the national level cannot be discounted, because more and
more Italians have grown weary of traditional political parties. Decades
of mismanagement and corruption have led to voter mistrust in the
establishment parties' ability to turn around Italy's tepid economic
growth and persistently high unemployment. Still, a government led by
the Five Star Movement would face many of the same constraints as its