Photograph: Marco Di Lauro/Getty Images

Bond Market Is Right to Worry About Italian Vote

Investors are concerned that there's more at stake than just Italian constitutional reform.

In less than two weeks, Italians will vote in a referendum on whether to change the nation's constitution. Polls consistently suggest the government will lose the vote; even former Prime Minister Mario Monti told Bloomberg Television he's voting "no." And the bond market is signaling that there may be more at stake than just Prime Minister Matteo Renzi's job.

QuickTake Europe's Next Scary Referendum

Italy's 10-year borrowing cost has been steadily marching above that of Spain since the middle of the year. Italian yields had been lower than Spanish yields since the middle of last year; the premium investors demand to lend to Italy climbed to almost 0.6 percent this month, the highest level since 2011:

Rising Risks

Spread between 10-year Italian and Spanish government bond yields

Source: Bloomberg

German two-year yields, meantime, have just set a new record low of minus 0.71 percent. That's a clear sign that fixed-income investors are seeking havens, even amid a general rise in yields. "To what extent the Italian problem has dragged down the entire European government bond complex is not entirely clear but there is surely a head of steam building up which risks blowing its top on Dec. 5," says Anthony Peters, a strategist at Sol Capital.

What's worrying investors isn't Renzi's failure to implement his institutional reform package. The concern is what happens if, as expected, he resigns and there's an election. Holger Schmieding, the Chief Economist at Berenberg Bank in London, calculates that political parties either calling for a referendum on Italy's euro membership or expressing ambivalence to the project "might command more than 50 percent of the vote in the case of early elections," far more than in its EU neighbors:

Source: Berenberg Bank

Schmieding says he sees "a potential political crisis in Italy" as a key risk for Europe next year. Lorenzo Guerini, deputy-secretary of Renzi’s Democratic Party, told Bloomberg News reporter John Follain this week that the party will seek early elections by the summer of next year if it loses the plebiscite. With the Five Star Movement, which wants a euro-membership referendum, just behind the Democratic Party in the polls, there's a chance that an anti-euro party could hold the reins of Italian power by the middle of next year.

Even then, Five Star couldn't immediately threaten to abandon the euro. As Bloomberg Intelligence's Maxime Sbaihi has pointed out, "only an electoral victory, a stable parliamentary majority and, last but not least, a change in the constitution would allow them to hold a referendum on international treaties."

But there's another twist. Italy also introduced an electoral law in July called the Italicum, which gives bonus seats to the biggest winner in elections. Erik Nielsen, the chief economist at UniCredit SpA, says the change has created a "winning party takes it all system" which is "too dangerous in a multi-party system with an out-of-mainstream radical party in the running."

To be sure, while bond investors are punishing Italy on a relative basis, the shift in perceptions versus Spain isn't yet enough to hurt the country economically. On a weighted average basis, Italy pays 3.4 percent interest on its debts. The current 10-year borrowing cost is well below that; even after the recent jump, Italy's money is still cheaper than the average in recent years:

Twenty Years of Context

Italy's 10-year government bond yield

Source: Bloomberg

In the wake of the U.K. Brexit vote and the election of Donald Trump, there's a risk that we'll start jumping at shadows, perceiving world-changing implications in every pending political event. Italy's Dec. 4 constitutional referendum may be a case in point; it's not inevitable that the government will lose the vote, or that a loss will threaten further European Union turmoil, or that an early election will put Five Star in power. But the bond market is no mood to take chances. For fixed-income investors, the year could end with a bang, not a whimper.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Mark Gilbert at

    To contact the editor responsible for this story:
    Therese Raphael at

    Before it's here, it's on the Bloomberg Terminal.