Italian Referendum

In a year where populism has swept the ballot box, is Italy next? On December 4, the country will hold a referendum on whether to reform the size, powers and appointment process for Parliament's upper house, the Senate. If the referendum is approved, the Senate's powers would be greatly curtailed and size reduced. It would shrink from 315 members to 100, the government would no longer have to win a Senate confidence vote, fewer measures would require Senate approval and senators would be appointed by Italy's Regional Councils instead of directly elected. If passed, it would foster government stability and make it easier to pass badly needed reforms. But if it fails, many fear it will destabilize Italy's pro-euro government, potentially propelling anti-euro populists to power and raising the risk of a domino effect across the eurozone. In our view, however, fears of broader market impact are likely overstated.

Prime Minister Matteo Renzi proposed the referendum to mitigate the Senate's ability to block legislation and increase the Italian government's stability, through elimination of one confidence vote. However, he also indicated his government will step down if the referendum is defeated. Opposition parties, such as the Five Star Movement (M5S), are against the referendum, as they believe it gives too much control to the Prime Minister. Many believe a Renzi resignation could give M5S an opening to enter the national government.

Italy doesn't allow the publication of polls 15 days prior to an election or referendum, but the last polls indicated the "No" vote was ahead by about three points. PredictIt, a betting website similar to the late, great InTrade, puts the odds of the "No" vote prevailing at ~80%. But as US elections and the Brexit vote showed, polling and prediction have been unreliable lately. The considerable number of undecided voters (~20%) also suggests any poll isn't conclusive.

What would be the likely impact of a "Yes" or "No" outcome?

• "Yes" Vote Wins: A "Yes" result would likely provide stability to the Italian political environment and open the door for needed reforms. PM Renzi would probably view this as a mandate to continue pushing electoral and labor market reforms. Concerns surrounding Italian banks would likely ease, as a government would remain in place to act if support is needed.

• "No" Vote Wins: A "No" result would likely result in Renzi's resignation and create political uncertainty. It would be up to Italian President Sergio Mattarella to either call snap elections, push for the formation of a new government or appoint a technocrat as PM (as in 2011, when former President Giorgio Napolitano installed Mario Monti as PM after appointing him a lifetime Senator). Mattarella has already expressed disdain for snap elections, so the likely outcome would be some sort of caretaker government. Renzi could even be reappointed as PM, but given a very narrow mandate on which to focus. Italian banking concerns would likely increase, as political uncertainty might limit struggling banks' ability to raise capital or result in a government that's slow to offer support.

Markets are discounters of all widely known information, including polling and predictions on Italian politics. While a "No" vote would raise uncertainty, the markets have been digesting this for most of the year, and concerns over the referendum likely explain why Italy is one of the worst performing countries in the world this year (down over -20%). Markets have dealt with several date-certain political events this year, including Brexit and the US election. Uncertainty has fallen in the wake of each, and we expect markets to overcome this event as well and benefit from the additional clarity.

Italy makes up less than 1% of developed market equities and ~2% of global GDP-not nearly large enough to wallop global markets. Finally, Italy has had eight Prime Ministers since 2000, so an unstable political environment is nothing new. A "No" vote would essentially maintain the status quo and have limited impact on the rest of Europe. Although it would probably be an incremental positive for Italian and eurozone markets if the referendum is approved, especially with sentiment so negative, by the same token non-passage-and Italian gridlock-is likely already priced in.