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Ah, democracy! After the jitters of the French Presidential campaign and the surge of the populist AfD in Germany which once looked set to threaten Angel Merkel’s fourth term, Europe looks like a much better and stable place. Emanuel Macron has vanquished Marine le Pen and looks set to secure a sizeable majority in the Council of Deputies when the second round of voting concludes next Sunday, despite his La République En Marche! party being only a year old. Angela Merkel, meanwhile, as the ‘grande dame’ of Europe, looks set to prevail in September.
Against this backdrop of increased political stability, the Eurozone economy is storming ahead. The global economy itself is at its healthiest since the Great Financial Crisis. Having been initially led by the US, Europe that is now taking the lead. The latest composite PMI figure out of the US showed a reading of 53.6. For the Eurozone, it was 56.8.
As the US has come off the boil, and hopes of the inflationary ‘Trump trade’ have faded, medium-term interest rates have reversed downwards. The 10-year treasury yield has fallen almost 40 basis points in three months and, after the disappointing non-farm payrolls number of only 138,000 ten days ago, even this week’s expected rate rise no longer feels like quite the shoo-in it once did, despite the market’s 90%+ probability of it happening.
It is little wonder then that EUR/USD is so well supported. We have argued several times that the market was getting ahead of itself in its enthusiasm for the greenback and so it has proved. Despite Mario Draghi’s statement at the penultimate monetary policy press conference on 27 April that rates are expected "...to remain at present or lower levels for an extended period of time", since risks "remain tilted towards the downside", demand for the single currency has scarcely missed a beat.
Draghi reiterated this line of thought at the press conference following the latest ECB monetary policy meeting last Thursday, saying "...a very substantial degree of monetary accommodation is still needed" and that he stood ready to increase the asset purchase programme should conditions worsen. Given this consistently dovish tone, it is not difficult to imagine further significant euro strength when the rhetoric eventually becomes more hawkish. At this rate, however, this looks like something to think about for next year – and possibly well into next year.
Despite the eurozone’s sunnier political and economic outlooks, there remains a problem child in the form of Italy. Here, at a national level, Bepe Grillo’s Five Star Movement (‘M5S’), at 30%, is level with Matteo Renzi’s centre-left Democratic Party. The date of the next Italian election has not been decided but it must take place before 20 May 2018 and could happen as soon as this autumn. Although the establishment will have been encouraged by M5S’s poor performance in Sunday’s mayoral elections, the complexities of Italian politics mean that mayoral results are not necessarily translated at a national level and Italy’s economic performance has been moribund for years, encouraging the anti-establishment vote.
The debt burden, at over 130% of GDP is already way beyond the level above which debt, per se, tends to have a negative impact on GDP. Indeed, despite Q1 2017 expansion of 0.4%, Italy has still experienced no GDP growth in real terms since 2000. The electorate is bored with austerity and a vote for the anti-EU M5S would make the future of Europe interesting to say the least. The UK election last week provides ample evidence that opinion polls (with the stunning exception of John Curtice’s extraordinarily accurate exit poll) are not to be trusted. For all anyone really knows, M5S could even be ahead at a national level.
On the subject of the UK, hectares of forest were consumed by the British press over the weekend as opinion pieces swept in like a tsunami. Yet again, betting and financial markets were hopelessly wrong-footed. When Michael Gove said during the referendum campaign that ‘people had had enough of experts’, he had a point. It was almost as if the electorate was being deliberately obtuse. Anecdotally, there appears to have been a good deal of tactical voting but what caught out most commentators and forecasters was the social media campaign. This was orchestrated by the youth vote, with military precision, specifically to damage the Conservatives and included websites offering advice on tactical voting on a constituency-by-constituency basis, all spread on Facebook and Twitter. British politics has, overnight, become more polarised than at any time since the seventies. Theresa May’s credibility is utterly broken and quite how she will be able to negotiate anything other than her own exit is not at all clear.
Such a shock might have been expected to cause mayhem in financial markets but sterling quickly stabilised after a 2% sell-off (though it is trading badly again this morning at 1.2690 and 1.1315 against the dollar and euro respectively), while reaction in the stock and bond markets was particularly muted. Indeed, although the immediate future is very uncertain (particularly for Theresa May), the hung parliament is, at the very least, likely to reduce the probability of a hard Brexit.
Perhaps there will now have to be some sort of cross-party consensus on Brexit with another referendum on the outcome of negotiations. This is all likely to be so tedious for the vast majority of the British electorate that getting any sort of Brexit across the line now looks difficult. It has become even more of a poisoned chalice. May’s vision of a hard Brexit, involving leaving the Single Market and customs union has been completely rejected, while one could easily envisage a consensus on a soft Brexit being so soft that most people would not see the point in leaving the EU at all.
It takes only a little imagination to envisage a swift end to Theresa May’s avowed intent to commence Brexit negotiations in a week’s time and, instead, following another inconclusive election in the autumn, for the negotiations to centre on a reversal of the triggering of Article 50. This would require another referendum on EU membership but with the youth vote now galvanised, a second Leave vote seems highly unlikely. The army of EU negotiators in Brussels must be licking their lips.
This week sees Eurozone industrial production for April (tomorrow, expected +1.4% y/y) and inflation (Friday, headline CPI expected +1.4% and core CPI expected 0.9%).
In the UK, we await inflation data for May (tomorrow, CPI expected unchanged at 2.7%), comfortably outstripping average earnings for the three months to April (Wednesday, expected 2.4% y/y) and suggesting a continued squeeze on consumers.
The US sees inflation, earnings and retail sales data on Wednesday but unless these are wildly different from expectations, they will be overshadowed by the FOMC’s interest rate decision on the same day.
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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