The inconclusive polls sparked fears that the austerity programme started 13 months ago by the technocratic government led by Mario Monti will be brought to a halt.
European, US and later Asian stock markets tanked after Italian exit poll results, which seem to indicate that a second round of elections is needed.
The S&P 500 ended Monday 1.8% lower and the Dow Jones fell 1.5%. In Europe, Italy’s FTSE MIB was down more than 4% Tuesday morning, France’s CAC-40 was nearly 3% lower, Germany’s DAX fell 1.7% and the FTSE was trading 1.3% lower at the open.
The MSCI emerging markets index was down more than 1%.
This was in sharp contrast with Monday morning, when markets were still in the green as hopes of a more positive outcome prevailed. Some analysts say that this lack of worry until the hopes were irrevocably dashed is symptomatic of markets that are too dependent on the liquidity provided by central banks.
“The initial lack of financial market reaction appears to be testament to the overwhelming anesthesia of 'unconventional' central bank liquidity measures, which bode poorly for the long run given that at some stage markets will have to go 'cold turkey' as and when: excess liquidity a) is no longer provided, and b) eventually gradually withdrawn,” Marc Ostwald, a strategist with Monument Securities, wrote in a market note Tuesday morning.
Former Prime Minister Silvio Berlusconi, whose center-right party won 117 seats in the Senate, ruled out an alliance with Monti, saying that the results showed Italians were unhappy with the austerity measures introduced by the technocrat.
MARKET REVERSAL
But, as Carl Weinberg, chief economist at High Frequency Economics points out, “those reforms have reversed the course of Italy’s fiscal deficit, and the market sees them as a prerequisite for buying Italy’s bonds.”
Weinberg believes “the tail risk for a market reversal has become bigger.”
A second election could give even more clout to Berlusconi’s coalition, in his opinion. “Our view is that the tail risks are bigger in a second election,” he said. “We think the rise in Italy’s bond yields is merited, and the risk that investors may panic cannot be ignored.”
Analysts at Societe Generale say that, to put Italy back on a sustainable path, there is a need for an “extensive reboot,” with progress on all fronts of the structural reforms.
They note that Italy’s gross domestic product has fallen by 7% since the beginning of the global financial crisis and the public debt has ballooned to 127% of GDP.
Benoit Anne, head of emerging markets strategy at Societe Generale, said that while over the past few weeks the correlation between emerging European currencies and the euro seemed to have broken down, it might resurface now, and this is not good news for emerging markets currencies.
“In fact, this could well be very bad,” Anne said. “For we are back to watching the eurozone troubles and I can’t see how this can be good for EMEA.”
“As now already pretty clear, the growth outlook both in the eurozone and Central Europe is pretty grim. If some contagion fears were to resurface again on top of that, it would be hard for me to imagine how CEE FX could be well supported,” he added.
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