Equity and debt markets had a wild swing after the election of new government leaders in Italy, while there was little to no reaction over Spain’s similar vote. The reason for this discrepancy is that across most of Spain’s popular parties, there has been no sentiment to abandon the Euro and leave the E.U. On the other hand, Italy’s new populist leaders have thrown around the idea of exiting the European Union.
Upon the news of Italy’s vote, the price of their government debt fell sending yields skyrocketing. Each step Italy takes toward leaving the European Union makes their debt more risky. As a member of the European Union, Italy enjoys some of the financial perks such as the implied backing of all other members of the E.U. and the European Central Bank for monetary stimulus if things go awry. The vote inched them closer to moving away from this safety net for their already struggling economy.
The movement in price for Italy’s debt intuitively makes sense given the sentiment of the populist party voted into office. What is less clear is the reason for the large selloff in equity markets that these votes catalyzed. How does Italy leaving the E.U. make U.S. companies worth less money? Depending on who you ask, you will receive a different answer.
A commonly circulated explanation to this question is that the political unrest in both Spain and Italy is the result of their struggling economies. The U.S. stock market has thrived on the narrative of global synchronized growth, and when we look at the health of the United States’ economy it’s not such a stretch to believe that other countries must be doing well. When the struggles of countries like Spain and Italy appear in our headlines we are reminded that not all economies are on the same playing field. Holes begin to appear in the global growth narrative as we are reminded of the slow recovery and high unemployment rates of countries like Spain, Italy, and Greece.
The E.U. as a whole is a major piece of the puzzle when it comes to the global growth narrative. As we have discussed in other articles, the Eurozone has experienced an extraordinary amount of accommodative monetary policy and quantitative easing; the goal being to spur growth and therefore a recovery. The shifting sentiment in Italy to move away from the E.U. weakens the Union and spreads the idea that leaving could be the answer to all the problems of a struggling country.
Of course, we have seen this tale play out before through the Brexit vote. Though the details were different, the story was the same. Britain voted to leave the E.U. and global markets plummeted. That was back in the summer of 2016, and while many were foretelling the end of civilized society as we know it, most markets calmly regained their losses within two weeks. To be sure, Italy’s economy is in a much more precarious position than Britain’s and Britain never fully adopted the Euro in the first place. However, the impulse to overreact to this news remains the same. Italy’s economy and debt could certainly be in dire straits, but the impact to the world as a whole might be less severe than most media makes it out to be.
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