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Political Uncertainty Re-Emerges in Europe, Euro Volatility Spikes

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Political uncertainty re-emerged in Europe shortly after the being improved on French presidential election. Now, it is Italy's turn with a snap election later this year becoming increasingly likely. With major parties converging to a deal on a new electoral law, an early election might take place in coming months, probably synchronizing that of German's in September. The euro reacted negatively and declined to the lowest level in more than a week before rebound. The 10-year Italian-German yield spread soared to almost the highest level in a month on concerns that the rapidly-rising Five Star Movement, the populist, euro-skeptic political party, could eventually become part of the coalition in Italy and destablize European Union again.

Three major parties support German inspired system

The latest development is that at least three (Partito Democratico, Five Star Movement, and Forza Italia) out of the 4 major parties have shown support to the German-inspired electoral system, using proportional representation with a 5% threshold. The system is bad for small parties. As such, small political parties including the conservative Brothers of Italy, the centrists led by Foreign Minister Angelino Alfano, and the Progressive and Democratic Movement (MDP), which split off from the PD earlier this year, have opposed the reform. Yet, one advantage of the new system is that it reduces fragmentation in the parliament.

Opinion polls have suggested that it would be a neck and neck race between the anti-EU, populist Five Star Movement, led by Beppe Grillo Gianroberto Casaleggio, and the social- democratic Partito Democratico, lead by former PM Matteo Renzi. The market is concerned that the sentiment of anti-globalization and protectionism in EU would grow big again if Five Star Movement manages to become the largest party in Italy.

UK General Election on June 8

In a separate note, the UK general election would be held on June 8. The latest opinion poll suggested that Labors are narrowing the gap with Tories, increasing the uncertainty of the election outcome. Recall that PM Theresa May called for the election in order to cement her mandate in the Brexit negotiation with the EU. Her confidence was anchored by the strong support for Tories at the time with some polls showing that Tories at almost double the vote share of the Labour Party. However, the lead has dropped from almost 20 to below 10 recently. While a Tories' majority is still expected, the failure to get a landslide victory would likely increase the hurdle for the UK's Brexit negotiation with the EU, due to conflicting opinions at home.