Hans van Zwol
First, the projected rise of populist parties could create a more fragmented parliament. We are concerned about the weighting of pro-integration parties versus Eurosceptics, and increased fragmentation may complicate the nomination of the new president of the European Commission. This may influence the way international investors look at Europe. The political balancing act in the nomination of key positions is also important, whereby a balance has to be found between small and large countries and between northern and southern Europe. This will affect the nomination of the next ECB president in October, an element to which markets may be more sensitive.
The European election will also affect national politics, especially in Italy. If the League (the junior party in the country’s current coalition) emerges victorious in the European elections, it could aim for early national elections in autumn and hope to become the senior partner in a right-wing cabinet. Finally, the UK will send 73 members to the European Parliament until Brexit is dealt with, and they could also influence the selection of key positions.
We don’t expect the election results to significantly affect Eurozone government bond yields and the direction of Europe. Even if the populists gain 30% of seats, as recent polls have predicted, traditional parties should still be able to form a workable majority. Moreover, markets have already discounted a gain for populist parties. Volatility and risk aversion have recently risen, but we attribute this more to the US-China trade conflict. The market impact of political events is generally short-lived, with relatively little influence on the direction of markets.
The impact might be different for individual countries, especially Italy. A possible government reshuffle or even new elections makes markets nervous. The Italian spread over Germany has risen 40 bps, which also stems from the recent risk-off environment. There are good reasons to be cautious about Italian debt but markets could react positively on new elections, as a right-wing or centre-right coalition is seen as more market-friendly than M5S.
Source: Thomson Reuters Datastream, NN Investment Partners
Hans van Zwol, Senior Portfolio Manager Global Fixed Income: “Although current bond spreads look attractive (10yrs Italy is currently trading around 280 bps over Germany), we remain neutral Italian bonds. And given that sharp moves in Italian spreads could affect other countries, we stay neutral country spreads. The best example is Spain, which we find fundamentally attractive at current levels, but where we stay neutral simply because of the contagion risks.”
Source: Thomson Reuters Datastream
Patrick Moonen, Principal Strategist Multi Asset: “The biggest hurdle preventing the Eurozone from outperforming the US is the low interest-rate environment keeping the financial sector from outperforming. Secular stagnation fears are mounting, which means investors will require a higher risk premium, as they already do for Japan. Low nominal growth is also a factor that keeps bond yields low. Finally, this weighs on relative earnings growth, which largely explains the Eurozone’s long-term underperformance relative to the US. Investors prefer to invest where growth is most likely, which is currently the US. We have a small overweight in US equities.”