Gulp

• French election uncertainty arguably well-priced at this point
• European growth recovery stalls after disappointing survey data?
• Fading US exceptionalism is still on the cards?

All eyes on France

With France’s far-right Rassemblement National (RN) party expected to secure a relative majority in a parliamentary election this Sunday, there is a lot at stake for markets. If it does, it will be the first time since World War II that a far-right party held power in the National Assembly.?

For investors, France’s debt problems are now under the microscope as the European Commission intends to place the country into an “excessive-deficit procedure”, meaning politicians are required to come up with a policy agenda to fix things soon. However, with polls suggesting the most likely outcome is a hung parliament, the risk of policy paralysis and delayed fiscal consolidation looms.

An alternative scenario, which should not be discounted, is an absolute majority for the far right. While RN has abandoned its most radical economic ideas (i.e. leaving the EU or Euro area), its policy agenda still increases the uncertainty around adherence to EU law and fiscal discipline.???

Whatever the outcome, markets already appear to be pricing a risk premium to compensate for the economic uncertainty. Since Macron’s snap election announcement, French sovereign spreads are trading near their 2017 highs and European risk assets have sold off aggressively.

Although the durability of further market stress remains unknown, financial markets retain the potential to act as a disciplinary mechanism for politicians, similar to the 2018 Italian election or 2022 UK budget crisis. For those brave souls willing to fade the recent extreme moves, the return asymmetry looks increasingly positively skewed.?

From waning to waxing US exceptionalism

Beyond the French election, the narrative for Europe had started to evolve in a modestly favourable direction but was interrupted last week after disappointing PMI survey data, with misses across sectors (manufacturing and services) and countries (France and Germany). Negative election sentiment likely played some role but was also broad enough to suggest the recovery will be bumpy.

Nevertheless, this represents a single monthly data point and it’s important to look across a breadth of measures to assess macro trends. Real-time estimates of GDP growth, as well as economist forecast changes, suggest that Europe is still improving relative to the US.

Investors have a tendency to underreact to such inflection points in trends. But the recovery in growth is not just a developed market (DM) phenomenon and is visible in emerging markets (EM) too. This is largely the result of improving Chinese domestic demand, as well as better global trade flows benefitting export markets like Korea and Taiwan. The potential for a sustained cyclical swing towards EM outperformance should not be ignored either.?

Investment conclusion:

The potential for political outcomes to disrupt European economic optimism is unlikely to disappear from the market narrative just yet. However, the latest data and pricing of market risks suggest that the bar for a positive surprise is arguably low. For investors, the key message is to stay invested and not let your nerves dictate when to get in or out of the market.

As usual we cover these themes and more in our weekly ‘Word on the Street’ podcast. Find out more, here.

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