Add Italy to the list of headline risk

by: , Managing Director, Economist, and Portfolio Manager, New York Life Investment Management

The political drama in Italy is the latest headwind for risk assets and the global economy.

Italy formed a new government, consisting of two populist parties. One wishes to increase government spending, the other aims to lower taxes. The combination could result in significantly higher deficits, resulting in some conflicts within the European Union, and discussions over the fiscal policy.

The resulting surge in spreads of Italian bonds to German bunds was another reminder of market volatility and prior events, like the Greek debt crisis in 2010 and Brexit concerns in 2016.

Italian bond yields

June 2008 – June 2018

Source: Bloomberg, as of 6/18/18. Past performance is no guarantee of future results, which will vary. You cannot invest directly in an index.

The probability of an Italian exit is low in our view, but not negligible

The two parties appear determined to take a hard-line stance against rules governing fiscal policy in the euro area. This may bring into question Italy’s commitment to the euro. That said, current polls indicate strong pro-euro sentiment among the general population.

The bigger problem is the structural issues

The Italian government debt burden is too high, at 130% of gross domestic product (GDP), and unemployment stands above 10%. There is a tremendous need for structural reform that encourages productivity and economic growth.

Italian debt situation

December 1960 – December 2018

Source: Bloomberg, as of 6/1/18. Past performance is no guarantee of future results, which will vary. You cannot invest directly in an index.

Italian unemployment

January 2004 – April 2018

Source: Bloomberg, as of 4/18/18. Past performance is no guarantee of future results, which will vary. You cannot invest directly in an index.

Europe’s economy remains strong

Europe’s economy in general is in much better shape than it was six or seven years ago, when the euro crisis was raging. Italy has been a weak link in Europe and it is not a big contributor to European growth overall. France, Spain, and Germany are much larger contributors. Despite pockets of weakness, global growth is still solid, and we bet that the global economic expansion will continue.

Stay invested

Events in Italy continue to cause a stir in the market, with signs that this story will be lingering in the background for weeks to come. That said, we believe U.S. bond yields and global equity markets will move higher again. Capital markets, especially currencies, will remain choppy in the near term, given growth concerns and political cross currents.

Global Purchasing Managers’ Index

Source: Bloomberg, as of 5/18/18. Past performance is no guarantee of future results, which will vary. You cannot invest directly in an index.

Watch: Market Insights

About risk

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J.P. Morgan Global Manufacturing PMI gives an overview of the global manufacturing sector. It is based on monthly surveys of over 10,000 purchasing executives from 32 of the world’s leading economies, including the U.S., Japan, Germany, France and China which together account for an estimated 89 percent of global manufacturing output. It reflects changes in global output, employment, new orders and prices.

The Purchasing Managers’ Index (PMI) is an indicator of economic health for manufacturing and service sectors. The purpose of the PMI is to provide information about current business conditions to company decision makers, analysts and purchasing managers.

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Poul Kristensen, CFA

Managing Director, Economist, and Portfolio Manager, New York Life Investment Management

Poul Kristensen, CFA is Managing Director, Economist, and Portfolio Manager with New York Life Investment Management’s Strategic Asset Allocation & Solutions (SAS) Group

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