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As expected, the "no" votes won in the Italian referendum. Prime Minister Matteo Renzi conceded defeat at his residence, Palazzo Chigi, and announced that he will tender his resignation on Monday afternoon, stating: "My experience in government ends here."
Another leader bites the referendum dust.
This vote is likely to rattle markets in the near term, as it represents a major win for the euroskeptic Five Star Movement. By Sunday evening, the euro had fallen to a 20-month low and U.S. markets were set to fall at the open, but on Monday morning the euro came back and stocks climbed as the initial shock wore off. Still, Italian banks are hit hard, which is a serious blow to the bank-heavy Italian MIB stock index.
The world's eighth-largest economy and the eurozone's third-largest now has to cobble together its 64th government in the past 70 years, which illustrates just why there has been a push to reform the Constitution. The stability of Italy's banks and its economy during this period will now seriously come into question, which has consequences for the rest of the eurozone.
This instability will call into question the plans by a consortium of banks to rescue the struggling Banca Monte dei Paschi di Siena, which is looking to raise around $5.3 billion to fend off its impending collapse. If political chaos ensues, potential investors may balk, which would then mean state intervention. That is something that Germany's Chancellor Angela Merkel has been against, but many consider Monte dei Paschi the potential first domino that could start a chain reaction across the still-struggling European banking sector.
The failure of Monte dei Paschi could easily have an impact on Germany's struggling Deutsche Bank (DB) - Get Deutsche Bank AG Report , which lost 90% of its market cap over the past 10 years and 35% this year alone. Merkel has got to be getting nervous here as well, as to date she has expressed no intention of bailing out Deutsche. Should its woes worsen, a failure of this bank with its supercharged balance sheet would have a significant impact on the German economy as well as the global banking -- this one is a too-big-to-fail on steroids.
Focus will now turn to the European Central Bank, which is preparing for a major meeting later this week to decide on the future of its $1.8 trillion bond purchase program, which is expiring in March. The ECB may feel pressure to focus its attention on Italian bonds to calm markets, which could evolve into political dynamite if the central bank is seen to be aiding and favoring one country over others.
Get that seat belt tight across your lap: 2017 has the potential to be one serious rollercoaster ride.
Why? Because national elections are set to occur in three of the European Union's founding members in 2017. That was before this Italian referendum vote, which means we're likely to see Italy added to that list. And that makes for four national elections and four potentially new governments, each with their own agenda.
All the nations with upcoming elections have experienced rising populist movements, many with far-right leanings. While most voters realize their countries are in desperate need of reforms, the utter lack of faith in the machine of government bureaucracy has created an antiestablishment attitude that has the potential to eclipse all else, as it did on Sunday in Italy. Given the state of the majority of the European economies, this trend is likely to make business leaders and the markets nervous. While an Italian exit from the European Union is anything but imminent, the likelihood of it occurring at some point in the future is now materially higher.
Germany's Merkel is facing increasing pressure. France's Hollande has already declared he will not seek reelection. The United Kingdom's David Cameron has already stepped down. All this uncertainty and potential volatility is a headwind to the European economy, much like the presidential election in the United States kept many a business decision on hold. This also makes the euro as a currency and European stock and bond markets less attractive than the U.S., which gives even more reason for the dollar to strengthen. We've seen U.S. futures rebound likely due in part to the realization that once again U.S. stocks are one of the best houses in a questionable neighborhood.
The challenge here for investors is that we can't know exactly how various political actors may respond to these events, and their reactions could, at least in the near-to- medium term, completely alter market fundamentals. For example, this vote is not good for Italian bonds, but if Mr. Market gets the sense that the ECB will hop on in as a major buyer, then this could be an opportunity. We'll be watching for indications of how the major players will respond and make our moves when probabilities are more definable.
Chris Versace & Lenore Hawkins
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned. Versace manages a portfolio that owns shares in FB.
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