Mr. Matteo Renzi resigned after the referendum defeat: (http://www.npr.org/sections/thetwo-way/2016/12/04/504356413/italian-voters-reject-referendum-prompting-prime-ministers-resignation).
This vote will rattle European and global markets because of concerns about the country’s economic future and support of populist parties. It is prompting worries about plans by a consortium of banks to come forward. Investors now fear that the victory for NO could destabilize the banking sector. They could rule against a rescue Banca Monte dei Paschi of Siena:( (https://www.bloomberg.com/news/articles/2016-12-02/italian-banks-flirt-with-disaster-again-as-government-teeters).
Italy has voted on a constitutional referendum. The decision of the current Italian Prime Minister Matteo Renzi is to step down from office which has added to the uncertainty and risk.
After Brexit and the US Presidential elections, this is the third most watched event of this year. Brexit produced a knee-jerk reaction, while the US elections have seen a more sustained rally. Hence, it’s important to understand the Italian referendum and position ourselves accordingly to profit from it.
What is the referendum about?
Italy has seen 63 governments since the World War II, which shows the kind of political instability in the nation. Along with that, it is a humongous task in Italy to get any reform pushed through by the government, because both the Senate and the Lower house have equal powers, which was done to avoid another Benito Mussolini rising to power.
However, this has also resulted in a logjam for approving new bills, because both the senate and the lower house pass the bills to and fro for ages. Sometimes it takes decades to get any reform approved.
The current Prime Minister Matteo Renzi, therefore, has proposed a reform to speed up the reform process. To achieve that, he has proposed to cut the strength of the senate to one-third, abolish the layers of government overlap between the center and the regions and give more powers to the Prime Minister.
So why have people been opposing it?
Renzi’s opponents say that the reform will put more powers in the hands of the Prime Minister, making him invincible. Even if a corrupt and inefficient leader becomes the Prime Minister, it is difficult to remove and replace him.
They say that the reform did not address the real problem with the economy and the nation.
What is the political fallout of the referendum being defeated?
The markets fear that if the referendum is defeated by a large vote, Renzi will resign and the opposition parties will ask for early elections, which are due in 2018.
The markets fear that if early elections are called, the anti-euro, populist party, Five Star Movement(M5S), led by Comedian and blogger Beppe Grillo will come to power.
What happens now that the M5S comes to power?
The M5S is opposed to the current structure of the Eurozone. It has said it will renegotiate the terms of agreements with the Eurozone. If the negotiations fail, they have threatened to go to the public to decide whether they want to stay in the Eurozone or opt for an exit like the U.K.
Among the top three Euro nations, Germany, France and Italy, Italians are now more inclined to quit the Eurozone. The current support for the single currency in Italy is 67%, but we know how things can change quickly. Hence, a risk of a breakup of the Eurozone remains very strong, similar to the Brexit type referendum.
What are the financial implications of this defeat of the referendum?
The spread between the Italian bonds and the German bunds will widen sharply(shown in the chart below).
Italian banks are teetering on the brink of a financial crisis (http://www.zerohedge.com/news/2016-11-27/eight-italian-banks-may-fail-if-renzi-loses-referendum), with a huge burden of bad loans. The chart below, sourced from The Wall Street Journal, shows the annual cost of insuring against a default on $10 million of debt for five years using credit-default swaps.
The overview of the markets after the vote:( http://www.cnbc.com/2016/12/05/live-renzi-steps-down-as-prime-minister-after-italy-rejects-his-reform-plan.html).
Look for another financial rolecoaster ride in the markets as ripple effects take hold
Italy’s No.3 lender by assets and the most troubled bank in Europe, Banca Monte dei Paschi di Siena will certainly need a bailout, it has lost 84% of its market value in 2016. The markets will then shift focus on to the other troubled banks in Europe like Deutsche Bank. A banking crisis is certainly in the cards if the European Central Bank is unable to manage the situation at hand.
The Euro, which has tanked to multi-year lows against the dollar will take another nosedive and fall below the critical support level of 1.04624. The EUR/USD downtrend was unable to break below the major support zone from the weekly chart.
JPMorgan will decide whether to put together a plan to go ahead with a €5bn recapitalisation, the FT reports, citing people informed of the plan.
Senior bankers will decide whether to pursue their underwriting commitments or exercise their right to drop the transaction due to potential adverse market conditions
The risk off trade in Europe is likely to see a flight to safety and into the U.S. dollar. Investors are unlikely to remain invested heavily in Europe, where the uncertainty remains high and talks of an eventual break up of the Euro will gather steam. U.S. stocks will get a boost of fresh investments considering the potential brighter prospects in the U.S. with the new President at the helm.
The dollar is likely to break out to new highs.
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Over the next few weeks, I will keep a close eye on this situation for new potential profitable trade setups .My subscribers will be Immediately alerted!
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[Image Courtesy of Wikipedia]