Managers on alert ahead of weekend of Euro drama

Managers on alert ahead of weekend of Euro drama
 Italian prime minister Matteo Renzi has gambled his job on a ‘yes’ outcome in the December 4 referendum

Fund managers have expressed caution over both European cyclicals and defensives ahead of this weekend’s referendum in Italy and general election re-run in neighbouring Austria.

Italians go to the polls on December 4 to decide whether to amend the constitution and grant greater powers to the lower parliamentary house – a move that, if approved, could allow greater political reform. On the same day, Austria has a repeat of its presidential election, with an increased chance the far-right Freedom Party (FPÖ) candidate Norbert Hofer could take charge.

Both could lead to significant upheaval. Italian prime minister Matteo Renzi has gambled his job on a ‘yes’ outcome in the referendum, meaning a potential general election and greater anti-EU representation in parliament if ‘no’ prevails. Polls suggest support for a ‘yes’ vote is as low as 34 per cent.

Austria’s vote would give further impetus to the nationalist movements taking charge in Europe and further afield.

Fund managers have said the likely ‘no’ vote in Italy would be viewed as another act of political protest, weakening the Italian market, particularly in fixed income. They predicted it would put further pressure on the already fragile banking sector and induce a sell off in bond proxies.

Maria Paola Toschi, global market strategist at JPMorgan Asset Management, said the most important reaction to the referendum result will be in the bond market, specifically the direction of yields on Italian government debt.

“In the event of a ‘no’ result, we could see a short-term spike upwards in yields. This could have implications for sectors of the equity market such as utilities, energy and telecommunications, which are historically sensitive to rate moves,” she added.

But the gravest effect would be on the beleaguered banking sector, according to Fidelity investment director Andrea Iannelli – despite financials often performing better when bonds sell off. He said two of the country’s largest banks are set to undertake issuance programmes that would be hampered by a ‘no’ outcome.

Mr Iannelli said that heightened political tensions from Mr Renzi’s resignation would increase pressure on UniCredit, Italy’s second largest bank by assets, and Monte dei Paschi, the third largest.

Mr Iannelli warned this could lead to nationalisation of the Monte dei Paschi bank in a worst-case scenario. “Ripple effects would be felt across the sector and might make it more difficult for UniCredit to complete a capital raising in 2017. For bond holders, the focus remains on a faster clean-up of banks’ balance sheets without triggering bail-ins,” he added.

Institutions are also worried. The European Central Bank (ECB) issued a warning last week that rising political uncertainty in Europe has intensified the risk of an abrupt market correction, posing a threat to banks, stability and economic growth.

In its twice yearly Financial Stability Review, the ECB stated “elevated geopolitical tensions and heightened political uncertainty have the potential to reignite global risk-aversion and to trigger a major confidence shock”.