European Politics Beyond the UK Referendum

Sterling is hovering around seven cents above last week's lows as many short-term participants better position themselves for the UK to vote to say in the EU, even though many opinion polls show a statistical dead heat.   The German Constitutional Court dismissed claims that the ECB's Outright Market Transactions does violates the German Constitution. 

Italy's run-off for local elections was held over the past weekend.  The 5-Star Movement (MS5) emerged as the second most important political force in Italy, capturing the mayoral posts in Rome and Turin.  MS5 candidates won nearly where ever they ran.  They drew support from right and center voters. It appeared MS5 candidates campaigned not on ideological positions, but on the promise for more efficient and less corrupt local government.  This seemed to have helped Raggi secured a little more than 2/3 of the vote in Rome to become its first woman mayor.  

The former center-left (PD) was forced out last year due to financial scandal.  Raggi campaigned for greater transparency, including how local public contracts are awarded, had wide appeal.  Of course, the MS5 candidates are not the first to promise such basic reforms.  However, by actually delivering better local government could catapult the MS5 on the national level.  

On one hand, the newly elected MS5 candidates have sufficient time before the next parliament election that must be held by May 2018. On the other hand, a national election could be forced sooner.  The key Italian political event this year may not be these local elections, but the constitutional referendum in October.  

As a critical part of the political reforms, Prime Minister Renzi is seeking constitutional changes that will weaken the Senate.  The reforms would slash its size by more than 2/3 and strip it of much of its power, including its ability to topple a government.    Renzi, who is Italy's third successive unelected Italian Prime Minister, has indicated he views the referendum as a vote of confidence.  If his constitutional changes are not accepted, he promised to resign.  

In part, Italian politics have entered a new era.  Berlusconi, who was the last elected Italian Prime Minister and who has dominated, is a waning power.  This is facilitating a realignment in Italian politics.  Renzi's PD continues to be the largest political force, though remember, like all political parties, it too is a coalition with its own fissures.  The MS5 is challenging the center-right to be the second biggest party.  The far-right Northern League does not appear to be drawing the center-right vote, though it has a newly rejuvenated leadership.  

Spain goes to the polls this weekend.  Its political landscape is also in transition.  The national election at the end of last year was unable to produce a workable government.  Although the polls suggest very little movement since then, many are hopeful of a different result.  Rajoy's Popular Party (PP) likely remains the largest political force, but it will not secure a majority.  Its most likely partner is the new Ciudadanos, but the cost of a coalition may be a replacement for Rajoy.   Moreover, the latest polls suggest such a coalition may still not secure a majority.  

Since the December election, Podemos appears to have done the best.  It merged with a former communist group to form Unidos Podemos ("Together We Can").  It appears to be polling around 25%-28% and with its close allies could secure 85-95 seats, up from 71 seats in December.   The problem is that it is drawing support from the Socialist, which previously was the second largest party behind the PP.  The Socialists are polling 21%-22.5% of the popular vote, which may translate into 78-85 seats.  It got 90 seats in the December election. 

Parliament is 350-seats, suggesting it is possible that Unidos Podemos coupled with the Socialists could form a majority government.  One of the difficulties is that Podemos has been insisting on recognizing Catalonia's right for a referendum on its independence, which the Socialists have rejected.   However, as the Lib-Dems experienced in the UK and the SPD have experienced in Germany, the Socialists in Spain would jeopardize their standing (branding?) if they were to support a minority government or join the center-right in a coalition government. 

Over the past one- and three-month periods, Spanish assets have outperformed Italian assets.  Spain's 10-year bond yield is off six bp over the past month, twice the decline that Italy's 10-year benchmark has experienced.  Over the past three months, Italy's 10-year yield is up nearly 20 bp while Spain's has risen seven bp.  

Both countries equities markets have fallen over the past month, while the Dow Jones Stoxx 600 is up a little less than one percent at the same time.  Italy is off one percent, and Spain is off 2%.  During the past three months, Italian shares of off 6.7% and Spanish shares of down 3.8%.  The Dow Jones Stoxx 600i is flat. 

It may take a week or two after the Spanish election to see if a government can be formed.  There is much pressure to do so.  If a government can be formed, then the focus will shift to negotiating with the EU about this year's budget overrun and next year's plans.    The leaders of Italy's PD are expected to meet at the end of the week.  However, after the summer, the October referendum may cast a pall over Italian assets and may lead to some under-performance.

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