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What have we been up to


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Europe faces up to multiple political events

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The shocks just keep coming – Leicester City, Brexit, Trump, Lincoln City – and now we face Dutch, French and German elections. For all the bluster of peroxide blond, Geert Wilders, and notwithstanding the fact that he has just edged into the lead in the opinion polls with just over 20%, the Netherlands will not succumb to his extremism for the simple reason that all other parties have refused to work with him. Therefore, he needs an outright majority or nothing. That is why Wilder’s party, the PVV, is 3/2 on to win the most seats but he himself is 3/1 against being the next Prime Minister.

France is similar in a way and more significant. Here, Marine le Pen is 4/1 on to win the first round but 5/2 against being the next President. However, the odds against the favourite, Emmanuel Macron, are not much shorter at 7/4. It is, of course widely assumed that the French electorate will overwhelmingly back the Front National in the first round as a protest, before swinging sharply back to reality in the second. Certainly, we have seen this before.

The financial markets seem to regard Le Pen’s second-round failure as inevitable. While it is true that 10 year French bond yields have risen to 73 basis points over Bunds, this hardly reflects the risk of a Le Pen victory, given that she is running, if not neck and neck with Macron, only a length behind, with what is still a long run-in ahead. It is worth reminding oneself that a le Pen victory would mean the end of the EU and the euro as we know them. What would remain of the euro were France to restore the Franc, is a deeply speculative question. However, we can safely assume that the single currency would deviate sharply from its current levels, depending on which European member states continued to use it.

An extreme scenario would be a distillation down to the northern core of Germany, Austria, the Netherlands and Finland which could easily see GBP/EUR, currently 1.1750, collapse substantially below parity – a 30% appreciation of the euro would take the rate to 0.9038. Less likely would be that the northern states exited the euro, leaving it to the Club Med, in which case GBP/EUR might easily trade at 1.6000 or higher. About the only thing one can say with certainty is that whichever currency Germany ends up in, whether new or old, will be stronger than the current euro.

Such conjecture will be regarded as alarmist by many, particularly in the financial community where Brexit and Trump came as particular surprises. As regards the French election, just as ahead of the Brexit referendum, there is a palpable sense of group-think. It should not be assumed that, just because you do not think le Pen will be elected – and do not even know anyone who does – the outcome is a fait accompli. In the same way that the run-up to the Brexit referendum felt very different as one moved further from London, so insights into the French election are unlikely to be found in the salons of the 6th arrondissement, let alone in Knightsbridge or Canary Wharf.

The relatively good news is that there is still time to prepare for a seismic French shock. On the basis that the euro could move sharply either up or down, those with exposure should consider protecting their weak side with out-of-the money options. Many will recall that, in the immediate run-up to the Brexit referendum, FX options on sterling increased dramatically in price – not by nearly enough in the case of put options, as it transpired.     

Talking of sterling, the end of last week saw the pound briefly marked down by a full cent against the dollar to just below 1.2400 after disappointing retail sales data. Perhaps this portends the end of the UK consumer’s remarkable post-referendum resilience. Certainly, that would be the view of ex PM, Tony Blair, who last Thursday, having made his gilded descent from Planet Zarg, warned that we were heading for a cliff-edge and exhorted Remainers to ‘rise up’ against Brexit. His intervention seemed to many ears to be about as relevant as Sean Connery’s insistence that Scotland should vote for independence in 2015 – delivered from his tax-exile hidey-hole in the Bahamas.

It is not only the Dutch and French who face interesting elections this year. Germany votes in September and Angela Merkel wishes to keep voters’ attention away from Greece and the vast sums of German taxpayers’ cash that have been ‘invested’ to keep Greece in the euro and EU. Hence she has convened separate meetings with EC President, Jean-Claude Juncker (possibly also to discuss his forthcoming resignation, if reports in Italy’s La Repubblica are correct) and IMF Managing Director, Christine Lagarde, this Wednesday. Greece requires another €7.4 billion to avoid default in July.

The problem is that Merkel has promised her own CDU party that no more German money will be made available to Greece without further funds being committed by the IMF as well. Until recently, that might not have been too much of an issue. Nowadays, however, the US, while still the biggest contributor to the IMF coffers (17.5%, compared, for example, to Germany and the UK’s  5.6% and 4.2% respectively) is run by an administration that is, to put it mildly, eurosceptic. Merkel will be seeking reassurances from Lagarde that IMF support for Greece will be forthcoming. Given the recent comments from Ted Malloch, tipped to be Trump’s ambassador to the EU, that Greece should leave the euro – and investors should short it – such support is very far from certain.

This morning we have already seen data from Rightmove which recorded house prices as having risen by 2.3% in the year to February, down from last month’s 3.2% rise and against expectations of a 2.8% increase. Tomorrow sees Public Sector Net Borrowing for January which, at minus £16.4 billion, is expected to have been boosted by seasonal corporation tax and self-assessment receipts. Wednesday will see the second estimate of Q4 GDP which is expected to confirm the first estimate of +0.6% q/q (+2.2% y/y). In the US, tomorrow sees manufacturing and services PMI figures, which at 55.3 and 55.8 are expected to show the US economy continuing its robust expansion. Tomorrow also sees manufacturing and services PMI data for the Eurozone, which at 55.0 and 53.7, are expected to show the Eurozone playing catch-up, assisted by ongoing ECB asset purchases and two years of EUR weakness against the USD. This week’s data releases should prove uneventful but the politics, particularly Wednesday’s meetings in Germany, may prove fascinating.

All views expressed here are the author’s own and are based on information and data available at the time of writing.



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