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Four’s a crowd

The French go to the polls and Theresa May calls shock snap general election

Government bond yields have remained close to their lows during the past week, with worries ahead of the 1st round of the French election, as well as geopolitical concerns in Korea, keeping markets on a relatively nervous footing. We also had a shock announcement of a snap election in the UK, though with the Conservative Party widely expected to win an enhanced majority, the implications of this were felt more domestically than in global markets.

French polls appear to suggest that any two out of four candidates could conceivably make it to the 2nd round run off on 7 May. This creates six possible permutations, all of which look possible given the margin of error within poll sampling. In assessing these, we believe that risk assets should rally in the coming week in five out these six scenarios, with the danger being a Le Pen versus Melenchon outcome, which could lead to some large risk-off moves on fears that the future of the monetary union could again be called into question. Although this may be a gross simplification, were Le Pen or Melenchon to win office, it appears that France will be on a collision course with other EU states and could create a shock that would be enough to expose the weak links within the Union, making a crisis something of a self-fulfilling prophecy. At the same time, this remains an unlikely outcome in our view, and in a two-horse race, we are likely to see an outcome where Macron or Fillon emerges as a clear front-runner following this weekend.

On the assumption that the French election will provide a market friendly winner, we believe that eurozone assets may be poised to rally strongly in the next few weeks as political risk declines. In this context, our preference has been to adopt a long position in corporate and sovereign spreads in the run-up to the polls, but the sheer unpredictability of a four-horse race creates a real sense of uncertainty. As a result we believe that it may be appropriate to wait until the start of next week before adding to positions, as we believe that the 1st round of voting is difficult to forecast accurately, whereas the 2nd round of voting should be much more straight forward.

In assessing these, we believe that risk assets should rally in the coming week in five out these six scenarios, with the danger being a Le Pen versus Melenchon outcome.

Elsewhere in global markets this week, we have been interested in signs suggesting that recent moves may be starting to run out of momentum at some key technical levels, which may become important for model driven investors. US rates have reached levels seen on 11 November just after the US election, as the ‘Trump Bump’ has turned into a ‘Trump Dump’ and interest rate futures have rallied to discount less than one Fed hike in the rest of 2017 and only one move the following year. We feel this is strongly out of line with what is justified by fundamentals and Federal Reserve commentary continues to be consistent with a policy of rate normalisation, with a series of hikes likely over the quarters ahead, with Federal Open Market Committee speakers highlighting that a broadly neutral stance is deemed appropriate at this point. In our view, the US expansion is not reliant on Trump fiscal easing. In China, strong data this week confirms that the economy retains strong momentum, even if the period of ‘peak’ stimulus is now behind us.

For sure, there is plenty to discuss in the markets at the current time and the brevity of a weekly email means that it is hard to cover everything going on. Suffice to say, the current backdrop appears rich in opportunity and notwithstanding a difficult couple of weeks, where we have given back a significant portion of the gains recorded at the start of this year, we believe that we are well placed to capitalise on the opportunities we expect to come our way. Politics and policy continue to drive the macro opportunity set and at the moment it seems like we can’t get enough of elections, with the UK throwing us an unexpected curveball.

Indeed, although Theresa May is expected to increase her Parliamentary majority from 12 to 100 or more (according to a number of polling sites), it is worth reflecting that the odds on her being Prime Minister 12 months ago were far more remote than those for Jeremy Corbyn are today. We have learned that strange things can happen in politics, and although it is possible that we could witness an outcome leading to catastrophic losses for the Labour Party, there is a scenario that in 2 months from now, radical unreformed left wing socialists are running both the UK as well as France. As one muses on recent developments, it is tempting to start to question the functioning of Western Democracy, however, in Austria, the Netherlands and seemingly Germany there has been a rejection of far right wing parties this year and voters have shown that they can be trusted. That said, it is becoming harder to lecture those countries which are run as one-party states – and should the Tories effectively decimate the Labour Party on 8 June, one wonders if the UK, under Chairman May, will be joining those ranks.

News Analysis

Mark Dowding

By
Mark Dowding
Co-Head of Investment Grade Debt
Published 21 April 2017
2 minute read
 

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Published April 2017