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Since most international investors are trying to get their heads around what is happening in Italy after the general elections held earlier this week, I thought I would offer the two pence of someone who lives and works in Tuscany, Central Italy, to try to clear some of the fog.

The Italian elections probably resulted in the worst possible scenario: a hung senate and an objective difficulty in forming a government. Laws must pass through both houses of Parliament in Italy in order to be approved.

International investors in particular have been unsettled by the comeback of ex-premier Berlusconi and the success of comedian-turned-politician Beppe Grillo with his Five Star Movement (M5S). To be sure, they both appealed to the 'belly' of the people, using a campaign rhetoric which bashed former premier Monti for his austerity push and, in the case of Grillo, questioned Italy's membership in the Euro currency. Certainly the worst case scenario for investors globally would be a new Italian parliament in the hands of a bunch of demagogues who would force Italy out of the Euro and reverse Mr. Monti's reforms, which fell well short of what the country needs but are still better than the wall of nothingness seen in the previous decades.

We should all take comfort in what Otto von Bismarck said: "People never lie so much as before an election, during a war, or after a hunt." Indeed, what was said right after the elections by both Berlusconi and particularly Grillo was more pragmatic than scary. Berlusconi said Italy has to have a government and he is willing to open talks, while Grillo was quick to clarify that he is not against Europe and the Euro.

Further, investors should also consider that Italian bond yields touched 5% and then retreated (they are currently around 4.75%). Even BTP-Bund spreads did not exceed 350 bps (see chart below). Just imagine what would have happened in a similar scenario just one year ago. Spreads would likely have rocketed past 500 bps and yields over 7%.

(click to enlarge)Daily_Y_S

Italian 10Y BTP yield German 10Y Bund yield and Italian 10Y BTP-German Bund spread

We all know what happened in the meantime: ECB President Draghi with his OMT was THE game-changer. Bond investors have known better than to fight a Central Bank for decades: there is reason to believe they should avoid challenging the ECB now.

In this sense, the current market environment may represent a good entry point in Italian government bonds. Could BTPs get cheaper? Probably, but that would imply a disastrous political scenario with the impossibility to form a government which could take care of even the reforms pretty much everyone agrees upon, such as reducing the number of seats in Parliament and changing the election law before a new vote.

Furthermore, as I pointed out in a previous article, 'it is entirely likely that a better world economy (although there are still risks) will make debt levels more bearable through increased economic activity and tax receipts. Also, the tide of austerity seems to have turned in Europe, whatever the still hawkish rhetoric in Berlin or Brussels. Austerity at a slower pace is also better news for growth.'

The latter is a particularly important point, as those leaders who based their election campaigns on an anti-austerity drive will save face just by riding along, as they will be able to tell their constituents that Brussels and Berlin saw reason thanks to them, while in reality developments have pointed in this direction for months already.

In essence, the message on Italy and the Euro is: keep calm and carry on. Trade carefully.

Source: Politics And Investments In Italy: Keep Calm And Carry On

Additional disclosure: The bank I work for might have long positions in some of the instruments mentioned in the article.