Daily Management Review

Euro Political Risk Trade Quashed By French Vote


Euro Political Risk Trade Quashed By French Vote
The spread of populism in Europe and the threat that might pose to the future of the euro was one of the trades of 2017 for the big financial investors who play on global political and economic risk in December.
However, the risks seem to have receded after with only a relatively traditional policy fight in prospect for Germany's vote in September and after two elections in a period of six months.
Defeat for Geert Wilders' Party for Freedom in the Netherlands and heads off Marine Le Pen’s promises to pull Paris out of the euro and potentially the European Union preceded Emmanuel Macron’s victory on Sunday night.
After a regional win on Sunday, perhaps worrying chiefly about the shape, Angela Merkel is again 6-8 points ahead in the polls, even though the situation looked threatened six weeks ago by Martin Schulz’s reboot of Germany’s Social Democrats (SPD).
And as many mainstream economists and its international partners have been saying Berlin should for a decade, major global investors say the worst they expect of a Schulz-led government is it might borrow and spend more even if he recovers.
With just 5 percent of the vote., support for the anti-euro Alternative for Germany has faded.
"For this year for sure it is the end of political risk for Europe," said Timothy Graf, head of European macro strategy with State Street Global Investors in London.
"The risk for the rest of the year, if anything, is not euro downside, it is euro upside."
Half of the overall equity risk premium of 6 percent earlier this year was made up of Europe's political risk premium, according to Citi's equity strategy team.
And the "political handbrake" which has had a major impact on investor, corporate and policymaker behavior, would be released by Macron's win even as the Dutch and French elections have changed the equity risks.
"We expect lower political risk to show in a lower PRP and ERP. A significant 'risk off' surge has been avoided," they wrote in a note to clients on Monday, reiterating conviction in their MEGA trade - "Making Europe Great Again".
Many are moving back to other concerns - about China, global commodities or the shape of U.S. and European monetary policy for the next year as the details of Monday's reaction on global financial markets suggest many came to this conclusion weeks ago.
When Le Pen and another anti-euro candidate, Jean-Luc Melenchon, was beaten in the first-round last month by Macron, the euro hit a roughly six-month high. And any new boost had largely dissipated by the time European traders got to their desks on Monday.
And down around half a percent after a year which has seen them gain more than a fifth in value, European stock markets also looked firmly in profit-taking mood.
"This marks an important shift in the narrative around European politics: not all popular discontent in Europe can be channeled as anti-EU or purely nationalistic," said Steven Andrew, macro fund manager at M&G Investments.
"Euro Area equities, currently attractively priced, could deliver substantial investment returns in the period ahead."