Italy – Right-wing landslide
Italian elections concluded with a solid victory of the right-wing coalition. The three parties overall obtained c.44% of the vote, meaning absolute majority in both houses within the current system. Brothers of Italy (Fratelli d’Italia, Giorgia Meloni’s party) saw the strongest affirmation, with 26% of the preferences, its historical high and roughly 8% above the second party (PD). The result opens potential for a very stable government, a very uncommon feature in Italian politics, provided unity within the coalition. Lega, junior partner of the winning coalition, has underperformed polls, totalling a c.8% result. This will make it less important within the government, and may even put some pressure on current leadership, an overall welcome sign by markets. Market-wise, the next few weeks will be important for the government. Meloni is not well known at international level and doesn’t have government experience. Markets are thus still in discovery phase, and ready to test the new government, especially in the current volatile environment. The Finance Ministry appointment and the upcoming budget will be the first key to watch. Consistency on the previous government message on Russia, EU funds and energy policy will also remain on markets radar.
UK – Mini-budget turns maxi
In the UK, the mini-budget aimed at providing energy cost relief turned into a massive fiscal expansion. Newly appointed Chancellor of the Exchequer Kwasi Kwarteng added to the bill a reform of the income tax system, a cut of the real estate stamp duty tax, and a cut of corporate taxes. The overall cuts are clearly aimed at the top earners, and the tone of the speech focused on prioritizing growth over redistributive concerns, as well as on repatriating bankers post the Brexit exodus. The size of the package is still unclear, but it could amount to £40bn per year, on top of the £60bn pencilled in for energy relief. The size would amount to a 5% of GDP expansion of the fiscal deficit. Moreover, considering the Bank of England just started quantitative tightening, gilt supply could amount to 7-8% of GDP over the next twelve months. The market has punished UK assets severely, as UK moves towards a strong fiscal expansion in a time of high inflation and rising interest rates. The Pound fell below 1.06 vs the Dollar, a multi-year low, and 5y gilts widened more than 50bp on the event, crossing 4%. The market is increasingly putting pressure on the Bank of England for an emergency hike, just two days after the central bank hiked policy rate by 50bp. Overall, we believe the UK has moves towards a fiscal expansion at the wrong economic juncture, as high inflation reduces budget space and post Brexit the overall macro credibility has reduced. We thus think the market will continue to test authorities, and UK assets will remain under pressure until the BOE delivers a bolder hike or the government comes out with a credible plan to restore the fiscal trajectory post 2022/23 expansion.
Macro volatility – Here to stay
Last week, we had a flurry of global central banks. The Federal Reserve came across hawkish, with a 75bp hike and a strong upward revision of its terminal rate to 4.6%, despite weakening growth forecasts in 2023. The Bank of England hiked 50bp and started quantitative tightening, an active program of balance sheet reduction following Covid expansion. We had large hikes in Norway and Switzerland too. In Japan, the BOJ was dovish and refrained from policy action, but had to rush and support the currency as the yen turned under pressure after the meeting. Generally, Asia FX remains under pressure as the interest rate differential vs the US widens in favour of the US. In fact, currencies remain under pressure in China and India too. In emerging markets, South Africa hiked rates while Brazil concluded its hiking cycle. Overall, central banks continue to be in race mode. The Fed is setting a hawkish tone in the market and global central banks need to choose between keeping up and hit the domestic yield curve (Europe) or lag and having FX under pressure (Japan). Countries where the central bank lags behind and the policy mix is not credible obtain pressure on both (UK). Overall, macro volatility remains high, and markets remain way less forgiving on government policy vs the times of indefinite QE. Rates / FX volatility is thus likely to persist in global markets, at least until we get some indication about a hiking cycle end in sight from the Fed.
Algebris Investments’ Global Credit Team
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