Italian Referendum Outlook for Forex, Commodities and Stocks

INTRODUCTION

On December 4, 2016 Italians will head to the polls to vote on the fate of constitutional reforms. The reforms have already been approved by the parliament but given the small approval margin they need to be put to a referendum. The most significant reform is an overhaul of the senate, which would lose most of its powers in an effort to expedite the minting of new laws, as the current process requires any proposal go through both chambers.

Given the complexity of the referendum and the far reaching implications of the changes to the senate there is a lot of skepticism from Italian voters with about a quarter still undecided ahead of the vote. The No camp has been ahead in the polls although there have been important advances from the Yes camp in the final weeks.

Italian Prime Minister Matteo Renzi has tied his political career on the outcome of the referendum further complicating the matter as it became a de facto vote of confidence as he has pledge to quit if the reforms are not approved.

The referendum is not an issue of Italexit (Italeave) but it could have European Union implications if Renzi does resign, as it would force the creation of a new government and open the door for the Five Star Movement to lead a charge to leave the single market.   The surprise victory of Brexit has exposed the cracks in the European project. The potential exit of one of the largest economies in the block is driving investor anxiety higher.

IMPORTANT DATES

4 December 2016

Referendum Impact on: Currency Markets

The EUR had depreciated versus the USD in the aftermath of the U.S. elections. The uncertainty surrounded by a long rollercoaster ride ended when Donald Trump was elected president. A surprise victory as polls had called a closer election was nevertheless well received by the market that abhors a power vacuum.

The EUR who reached yearly highs of 1.16 in May quickly lost traction as the U.S. Federal Reserve started hinting at a rate hike and the U.S. growth indicators showed a recovery from the dismal first two quarters of the year.

A win for the No vote would be detrimental to the EUR as in the short term there are not Italexit implications, but it does increase the probability of that event happening in the long term. A Yes camp win could boost the single currency ahead of the highly anticipated central bank actions at the end of the year by the European Central Bank (ECB) and the Fed.

Referendum Impact on: Gold^†

Gold recovered some of its shine in 2016 as political risk was at the forefront dictating market trends.  The yellow metal had a yearly high after the Brexit referendum but lost the momentum until the U.S. election reached its final stretch, only to give back gains once the outcome was secured.

Gold is getting bid as a hedge against the worst case scenario of a No win coupled with an immediate Renzi resignation that could drive funds to the safe haven metal. Overall the outlook for gold is muted by the strength of the USD on the back of the stimulus program projected by President-elect Trump and the Fed willing to let inflation build up and are at the ready with multiple interest rate hike in 2017.

Referendum Impact on: Oil^†

The Organization of the Petroleum Exporting Countries (OPEC) just reached an agreement to cut oil production in their headquarters in Vienna. The deal, which took almost all year to materialize, went form a freeze of production to an outright cut as prices kept slipping and a more drastic action was needed. The Italian referendum is not a primary driver of oil prices but a rejection of the referendum and its more pro-market promises could reduce growth in Italy as political stagnation follows the dissolution of the current government.

Crude prices won't be front and center after the results from the reform referendum start pouring in, but it could be weakened if the outcome destabilizes global markets by introducing more political risk into an already delicate agenda in 2017.

Referndum Impact on: Stock Markets^†

The Yes camp is made up of Renzi's Democratic Party and pro business interest groups seeking stability and a faster legislation process. Stock markets would thrive under those conditions so there a positive move is anticipated if Yes manages to add another upset to what has become a hard to predict year.

The No camp argues that the reforms would weaken the constitution and it's a belief shared by Renzi's opponents on both sides of the political spectrum. A No win could lead to Renzi's resignation (although he can still backtrack in the name of political stability) and open the door to having to form another government and the market uncertainty that could negatively impact stocks. Italian Financial institutions are in need of recapitalization and times of crisis increase the final cost, as investors will leave if there is the outlook for a political upheaval with no short-term solution available.

The negative impact of the No vote win could force the European Central Bank (ECB) to intervene as Italian bonds lose their appeal driving the cost of borrowing higher for the Italian government.

SUMMARY

Italian voting rules mandate a black out period when there is no polling available for the last two weeks ahead of the election. The last polls had the No vote ahead by 7 percent but without taking into consideration the expat vote, which could be a deciding factor. Given the misdirection and misunderstanding of polls a period of no information has helped not feed investor anxiety ahead of the vote. The fate of the EUR is only slightly implied in the referendum as this could mark the beginning of the end for the single currency, but a lot of more steps would need to be invoked before it comes to pass. A potential No win is the most likely scenario, which could have a negative impact on the EUR and European stock markets but leave Gold as a viable safe haven destination. A win by the Yes camp would have limited upside for the EUR and stock markets ahead of the European and American central bank appearances later in December.