If last year was the year investors were caught out by misleading polls, today’s market action suggests that investors are being caught out by mistrusting them. A collapse in near-term euro volatility, sharply higher equity markets and a compression in the spread between French and German government bonds emphasises the relief that Le Pen was not in a run-off with a far left-wing candidate.
Today, a 2nd round victory for Le Pen now appears a remote possibility, deliverable perhaps only in the event of an unanticipated development or scandal, as centrist support coalesces around Macron. Investors’ focus is likely to move towards German federal elections at the end of September. However, both leading candidates for the German Chancellorship are pro-EU and there appears relatively little to attract international speculators in a contest likely to be of greater relevance for Germany’s domestic policy agenda.
Compared to only six months ago, political uncertainty in Europe has diminished significantly. The political impasse in Spain has been broken in favour of a pro-EU administration while in the Netherlands the anti-EU Geert Wilders is not even at the negotiating table as the new Dutch coalition government is assembled.
Notwithstanding the still-high level of support for populist parties in Europe, if Macron becomes French president, the UK’s Brexit vote may start to look like an anomaly rather than the beginning of a trend of EU disintegration. We also note that in the US, Trump’s first 100 days have pivoted towards conventionality – a political impasse in terms healthcare, sabre-rattling foreign policy and lowered expectations in respect of the timing and extent of any US fiscal stimulus or tax reform.
Furthermore, the recent improvement in economic momentum in France, Exhibit 1, and declining unemployment clearly works against political protest movements. If Europe’s nascent economic recovery endures, the loss of momentum in terms of the popular desire for radical change could become permanent. While the political influence of populism to date will certainly still be felt as centrist politicians steal the best ideas of the new political contenders, the probability of abrupt change within the EU or eurozone seems to be ebbing modestly during 2017. Today, in each of equities, credit and FX markets risk premia have declined accordingly.
But as we highlighted in our earlier analysis of the French presidential election, aside from politics there remains a significant divergence in economic performance and indebtedness between France and Germany. The EU and its member states will have to demonstrate continued economic growth, widely spread across the region. A short-term cyclical lift would be insufficient to break away from the structural question marks raised over the last decade.