In the aftermath of yesterday’s hung parliament Italian vote, we said that at least in retrospect, JPM had made it very clear that should the current outcome materialize then at least according to the house of Morgan, one should sell Italian bonds. Sure enough, the same analyst Gianluca Salford just said to go “risk off” on BTPs.
Update after Italian vote: switch to risk-off portfolio
- The Italian elections provided a massive surprise and resulted in hung Parliament
- The strong political message is a rejection of austerity measures
- We believe there will be an attempt to form a grand coalition (70%), but see a risk of centre-left/centre coalition being enlarged by senators defecting from the centre-right or Grillo’s party (15%), or another election (15%)
- We turn tactically risk-off and recommend outright longs in 10Y Bunds, 5s/10s German curve flatteners and shorts in 10Y Italy
- LTRO repayments from peripheral banks are likely to slow down: close EONIA steepeners, while keeping long Jun13 ECB OIS
- Initiate Bund swap spread wideners and stay long gamma: buy 3Mx10Y straddles
- FX: EUR/USD falls to the high 1.20s in an adverse scenario of sovereign spread widening and German 2Y rates returning to crisis levels of 0%. Undershoots have been common during the sovereign crisis, though this Italian episode is much less existential than last year’s Greek elections. Positions look neutral now by two measures (IMMs and currency manager betas).
In line with 2006 and 2008 elections, polls, exit polls and instant polls all failed to give a correct indication of voting patterns, overestimating support for the Bersani’s centre-left and underestimating support for Berlusconi’s centre-right, but especially Grillo’s 5 Stars movement (Exhibit 1). In terms of seat allocation (Exhibit 2), in the Chamber (lower house) the centre-left managed to beat the centre-right by less than 1% and got the majority of seats. However it managed to win only eight of the seventeen regions due to the plurality vote system in the Senate (upper house). Getting a majority in the Senate is therefore very complicated. We see two negatives stemming from this vote: