#Italy
For a couple years now I’ve been tweeting about and writing about Political Risk as the main risk in the financial markets. The Reason is simple: for the last decade Central Banks have intervened in markets to suppress interest rates by keeping Sovereign Bond yields too low. By buying government debt in the market they made the price of this debt higher, forcing down the interest rate people receive for taking the risk of holding government bonds.
The inverse of this is what I have been focused on: by suppressing interest rates Central Banks have been mispricing Risk and specifically Political Risk. The Reason for this is that the main risk of government debt is Political. If they keep their house in order they should be able to repay their debts.
However, one fact that seems incontrovertible in recent years is that it is hard for governments to keep things the same. Political change has been on the rise. In other words, while Central Banks have been manipulating markets to fake like Political Risk is low, in the Real World Political Risk has been increasing all the time.
This is unsurprising to anyone who has been paying attention to the Real World over the last few years. From Greece to Brexit, from Bernie to Trump, Populism has been growing around the World. And for good reason. While the Central Banks propped up the system following the financial crisis, they also helped to exacerbate wealth and income inequality worldwide. Ordinary people have been left behind and they are fed up with the establishment who doesn’t care about them.
Enter Italy. Today they had an election after postponing it for quite some time. Prior to the election folks had contemplated that a coalition led the formerly-convicted and establishment chosen candidate Berlusconi would win the day. People thought this coalition would keep a patchwork of stability even though the Country has been crushed by the EU.
No matter how you cut it, Italy has suffered in the Euro, while Germany has thrived. Following the financial crisis, Italy faced restrictions on its ability to conduct fiscal stimulus and its economy suffered. Without the ability to devalue its currency, the export driven economy was crushed. Unemployment remains stubbornly high. Young people have to leave the country to find jobs. The economy is in the doldrums and banks have deep issues. Meanwhile, Germany is thriving.
This obviously horrendous situation for Italy was thought to be insufficient to mobilize the people at the polls. The establishment was supposed to keep things together.
For years I’ve been talking about Italy as the breaking point in Europe because it is so glaring how much the Country has suffered under the Euro, and yet their interest rates remain suppressed like the rest of the Eurozone. It makes no sense. In recent weeks I had become convinced that the establishment narrative would win the day.
I was right before. The establishment was wrong.
The final results are yet to come in but it looks like the 5 Star movement, the equivalent of the Bernie Sanders Progressive wing of Italy, is the leading results with more than 32% of the vote. Berlusconi’s Forza Italia, which was supposed to lead a coalition, has failed and will have ~14%, TRAILING the results the League (Lega), it’s supposed coalition partner who has ~17%. Their coalition seems to have fallen short of the 40% necessary to govern.
These results speak to the continued Populist wave sweeping the globe who are fed up with establishment politics. It also speaks to Political Risk. The Old Ways of doing things are no longer stable.
It remains to be seen what the immediate market reaction will be to these results but one thing is clear: Political Risk is extremely mispriced and when it corrects, the Credit Markets should suffer in a major way. Whether that happens tomorrow or in the coming months when the fight between Germany and Italy intensifies is unclear.
For now, there are no longer any excuses for complacency. The System is shaking.
Wake up before it is too late.
-DAL
