The shock waves have been felt right across the Eurozone. Italy has just had a cathartic revolution, with a stunning rejection of the old political order in the general election. A new order is sweeping the country’s hearts and mind. The anti-establishment 5-Star Movement of charismatic Beppe Grillo is on the crest of a populist wave. And nothing breeds more popularity than popularity itself. His party is now Kingmaker between the two mainstream parties, both left in massive disarray by the ground-breaking developments now taking place in Italy. If this revolution gains traction, Italy will not be the only country to feel its effects. Anti-austerity protest groups throughout the Eurozone will have a very strong spiritual champion.
Grillo’s iconoclasm has struck a major chord with the electorate, tired of the recession, disillusioned with the mainstream parties and fed up the bitter pill of austerity. The clear-cut message from voters is that they reject the fiscal prescription in PM Mario Monti’s medicine chest and are looking for a new political alternative. They like Grillo’s rejection of Italy’s pampered political culture, and his commitment to break down government bureaucracy and public sector monopolies. Grillo has also tapped into a popular vein. He is championing green credentials, pledged to get young unemployed back to work and to increase Italy’s minimum wage. So far so good in terms of political populism but what do Grillo economics mean for the long run. Will they be better or worse for Italy and for the Eurozone in the bigger picture?
The markets will have to get used to the concept of Grillonomics. One thing markets dislike with a passion is uncertainty and Grillonomics introduces a new dimension of political and economic risk into the equation. Grillo’s strategy on the economy is pretty vague to date. Even he admits to that. The bigger issue is his implied rejection of budget austerity. If he stays true to his word on turning back the tide on unemployment and reversing harsh government cuts in health and education spending, then fiscal attrition goes out of the window. If voters rejected Monti for this, then Grillo is far too shrewd to pick up the batten on budget bashing in anywhere near the same degree. Grillo says policy considerations will be on a measure-by-measure basis. Monti-style austerity is not an option in Grillo’s book.
This poses a major problem for the markets. If Grillonomics get the market’s thumbs down, Italian stocks and bonds will bear the brunt. Another run on the Italian bond markets might cause a major headache for the ECB’s defense line. Last year the ECB made it pretty clear that it was willing to intervene on any country’s behalf with open market bond purchases, so long as the country requested it and agreed the right conditions. Italy jettisoning budget stringency in favour of counter-cyclical stimulus would not be part of the ECB’s reckoning. It could block any future ECB intervention if the market falls into a crevasse again. In this respect the election-triggered spike in BTP spreads could extend a lot further. Given the uncertain backdrop, there are probably much better buying opportunities for Italian bonds at much lower levels, and probably a lot further ahead too when the dust settles from the election. Zero market exposure is probably the preferred strategy for the moment until a clearer political situation emerges.
As a footnote, protest movements across the Eurozone will be paying very close attention to Italian events. It is interesting that Grillo and the 5-Star Movement came from nothing in the last few years. His success has a lot to do with internet and social media and networking sites. If Grillo’s anti-austerity message starts to catch on in other troubled Eurozone countries then the contagion tail risk is not over yet. It could still have a lot more whip-lash effect to play out in the coming months. Eurozone bond convergence plays look set to be a volatility minefield ahead.
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