(Bloomberg) — Mario Draghi injected some confidence into bruised Italian markets after becoming prime minister in February 2021, driving reforms and forging a strong relationship with Brussels. His impending exit adds to a growing list of worries for domestic assets.
A right-wing coalition is widely expected to win Italy’s election on Sunday, bringing fresh uncertainty for investors already fretting over rising interest rates, an energy crunch and a potential recession. Such an outcome may raise doubts over the path of reforms that are a condition for the country to receive European Union funds to hasten its post-pandemic recovery.
“We anticipate increased volatility in the Italian equity market, though without extreme peaks ahead of the Sept. 25 vote and in the immediately following days,” said Fabio Caldato, a partner at Olympia Wealth Management. “Our concerns are for the medium term: the next government will face a difficult autumn and social tensions are likely.”
According to Ipek Ozkardeskaya, senior analyst at Swissquote, political risks will pressure Italian bond markets, with any widening in the Italy-Germany yield spread potentially weighing on the euro, “something that hasn’t boded well for European stocks generally this year.”
So far, markets have been relatively sanguine about the election risk, with far-right leaders moderating their tone during the campaign. Giorgia Meloni, who is seen as most likely to become Italy’s next prime minister, has advocated working constructively with Brussels.
UniCredit Group chief economics advisor Erik F. Nielsen is optimistic that Draghi’s comprehensive reform program will be implemented, something that would be “good news” for the country’s financial markets.
Still, with the appointment of a cabinet likely to take place no earlier than late next month, the main test of the new government will probably have to wait awhile, according to Goldman Sachs Group Inc. economist Sven Jari Stehn.
The appointment of ministers, particularly for the finance role, will be key for markets that are keen on a reliable figure to manage a economy that has historically been burdened by high debt.
Here’s a summary of the sectors to watch ahead of the elections:
Lenders including Intesa Sanpaolo SpA and UniCredit SpA are sensitive to the spread between Italian debt, known as BTPs, and German bunds, which may react to the outcome of the vote. Widening yields could weigh on financial stocks, which make up almost 30% of the FTSE MIB Index. The extra yield investor demand to hold Italian 10-year notes over German debt is 25 basis points higher since July 19 — the day before Draghi announced his resignation.
Despite current macro challenges, Italian banks are in better shape compared with past crises after years of painful restructuring. And the country’s lenders, along with European peers, may benefit in months ahead from higher interest rates boosting net interest income.
The planned capital increase of Banca Monte dei Paschi di Siena SpA will also be a key focus as the lender is seeking to raise new equity and cut about 4,000 jobs as part of a plan to boost capital reserves and profitability.
The two subgroups have a combined weighting of about 28% in the FTSE MIB, making the gauge potentially sensitive to measures taken at the local or EU level to address soaring energy prices. In May, Italy raised its windfall tax on energy industry profits to 25 % from 10%, with Eni SpA saying it will pay extraordinary tax of about 1.4 billion euros ($1.4 billion).
Meloni has indicated that a government led by her would take unilateral action to decouple power costs from gas prices if the EU doesn’t make quick progress on a joint effort. Last week, the European Commission unveiled a radical intervention plan, but member states, which have to sign off on the proposals, are still divided on the details.
READ: Salvini Plans $30 Billion Energy Subsidy to Aid Italian Business
Leadership announcements at state-controlled companies, several of which are large-caps on the Milan stock exchange, are due in the spring. Focus of the new cabinet will be on the top positions at Enel SpA, Eni, Terna SpA, Poste Italiane SpA and Leonardo SpA.
“A Meloni-led government could have a more invasive impact on the economy and on state-controlled companies,” also in terms of the so-called Golden Power procedure to safeguard strategic assets, said Matteo Brancolini, a fund manager at BPER Banca in Milan.
Italy’s state-backed lender will likely make its offer for Telecom Italia SpA’s network after elections, Bloomberg News reported this month. Draghi’s government has been discussing for months a potential merger between the former phone monopolist’s ultra-broadband network and its smaller, state-backed rival Open Fiber SpA.
Separately, Meloni’s Brothers of Italy is promoting a plan to take Telecom Italia private and sell off the phone company’s assets in a bid to cut its debt pile by more than half, people familiar with the matter said last month.
The gap between Italian and German 10-year bond yields has been relatively stable in recent weeks and below the year’s peak, reflecting pledges by right-wing coalition members to stick to the country’s plan for spending EU recovery funds.
But investors and strategists have warned of complacency and say Italy’s spread could surge past the year’s peak of 244 basis points if, as expected, the alliance assumes power. It was around 227 basis points on Tuesday.
Spreads for Italian high-grade corporate borrowers are at higher levels than the ones recorded during the last national elections in 2018, according to a Bloomberg index.
While this is partly due to the rising interest-rate environment, credit risk specifically spiked for Italy over the course of 2022. The spread differential between Italian corporate issuers and their European peers is at the widest in two years, according to Bloomberg Intelligence’s chief European credit strategist Mahesh Bhimalingam.
Italian credit spreads appear to be “discounting a lot already, as per the 2018 experience,” said Bank of America Corp. strategists including Barnaby Martin and Ioannis Angelakis. “The risks with policy uncertainty is that it returns Italy to a low productivity, low growth economy,” they wrote in a note, “fostering concerns again over debt sustainability.”