Macro Highlights: political uncertainty in the United States and Italy

Macro Highlights - 12/7/2016

Strong momentum in the labour market and the recent upturn in US manufacturing activity support the scenario of a hike in the fed funds rate at the FOMC meeting on 14 December, followed by a number of further upticks in 2017. Uncertainty over Italy’s political outlook could continue in the wake of the no vote on constitutional reform and the resignation of Prime Minister Matteo Renzi. Analysis by Lisa Turk and Sophie Casanova.

Green Party presidential nominee Jill Stein filed requests for a vote recount in three US states, Pennsylvania, Wisconsin and Michigan. These three states usually vote Democratic but were swept by the Republican candidate Donald Trump – by just a few tens of thousands of votes – in the race for the White House against Hillary Clinton. Mrs Clinton lost by 11,612 votes in Michigan (16 electors in the Electoral College), 22,871 votes in Wisconsin (10 electors) and 68,236 in Pennsylvania (20 electors), according to Bloomberg sources. In Pennsylvania, the recount has not yet been officially ordered, and Trump has asked the court to reject Ms Stein’s request. Ms Stein planned to petition the federal court on Monday, 5 December to order a recount.

Mrs Clinton handily won the popular vote by over 2 million votes, yet her rival received 306 Electoral College votes versus 232 for Mrs Clinton. This outcome is a result of the winner-take-all system under which the candidate who wins the majority of votes in a state is awarded all that state's electors. In order to win the presidential election, a candidate must receive at least 270 Electoral College votes. This means that Mrs Clinton would have to win the recount in all three states in order to be declared the winner of the overall election. It is unlikely that the three states will go her way, unless a massive amount of fraud and irregularities are discovered. Under federal law, recounts must be completed by 13 December, which is one week before the Electoral College meets on 19 December.

Getting back to economic fundamentals after several weeks of political turmoil in the United States, the latest data confirm the economic improvement that we had forecast for H2 2016. The ISM Manufacturing Index came in higher than expected, reaching 53.2 in November. It was buoyed by faster growth in the production component (see right-hand chart). While the improvement in both production and new orders is sparking hopes that manufacturing is poised to rise, the dollar’s recent rally could put the brakes on this sector in the coming months. The November jobs report showed that 178,000 new jobs were created, pulling the unemployment rate down to 4.6% (versus 4.9% in October). This is its lowest reading since August 2007 and 0.2% below the 4.8% level that members of the Fed Open Market Committee consider full employment (see left-hand chart). Part-time work for economic reasons also fell, going from 3.7% of the labour force in October to 3.6% in November. The only disappointments in the November report were the slight drop in the labour force participation rate (62.7% versus 62.8% in October) and average hourly earnings (+2.5% versus +2.8% in October), although these figures were still firm.



Solid momentum on the labour market and the improvement in manufacturing activity suggest that the FOMC will raise the fed funds rate when it meets on 14 December and several times in 2017. The stimulus planned by Mr Trump starting in 2017, which should lift both GDP and inflation, bolsters the monetary tightening argument. But the Fed also has to deal with a dollar that has risen by more than 6% since August and with rising short- and long-term Treasury yields (+0.27bp and 0.56bp respectively) since Mr Trump‘s election. These two factors tend to hold back growth. We now expect only two interest-rate hikes in 2017, while we forecast an average of 2% GDP growth and inflation over the same period.


In Italy, the defeat of the constitutional referendum on Sunday 4 December led Prime Minister Renzi to resign. 60% of Italian voters – with a turnout of nearly 68% – rejected the proposed constitutional reform, which aimed largely at reducing the role and power of the Senate. As discussed in last week’s Macro Highlights, the outcome of the vote and the prime minister’s resignation leave two major developments top monitor:

  1. The decision to be taken by Italy’s president following Mr Renzi’s resignation. Italy’s president Sergio Mattarella is now expected to appoint a prime minister or ask Mr Renzi to form a new government. The president could also opt for a technocratic government, something that the country has used several times in the past. In this latter case, the president would not necessarily have to call early elections (the next ones are scheduled for early 2018).
  2. The decision of the Italian constitutional court on whether the Italicum law will stand. The court announced that it would wait until after the 4 December referendum to hand down its decision on this electoral law, which gives an absolute majority of seats in the Chamber of Deputies to the party that wins the election (by getting 40% in the first round or winning the second round). One fear arising in recent weeks is that, as suggested by voting intentions measured by polls, a populist party could win in the legislative elections set for early 2018. Yet with the defeat of the referendum on 4 December, the Senate will continue to have the same powers as the Chamber of Deputies. Senators are elected under a system of proportional representation, which means that the Senate and the Chamber of Deputies will not necessarily be controlled by the same party. This could temper the influence of a populist party that held a majority in the Chamber of Deputies, but it could also increase the risk of political paralysis.


Uncertainty on Italy’s political outlook could last for a few months. But the defeat of the Senate reform referendum should not necessarily translate into high levels of instability and volatility on the markets. For one thing, a provisional government could carry on with some of the reforms and continue to clean up bank balance sheets. And then, although some international investors are wary of Italy and Italian bonds, the European Central Bank (ECB) could step in to limit the upturn in yields, as noted by Vitor Constancio on 24 November. Under the ECB’s rules, Italian bonds cannot make up more than 18% of the ECB's monthly sovereign debt purchases. But the ECB could temporarily set aside its asset purchase repartition ratio by countries or even end it at its meeting on 8 December, as we expect.


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