Article / 22 February 2017 at 11:00 GMT

Weekly Bond Update: Political uncertainty buffets Europe

Fixed Income trader / Saxo Bank
Denmark
  • Eurozone economic optimism clashes with worries over political upheaval
  • Holland, France and Germany headed for elections; possibly Italy too
  • French presidential election fraught with worries of a Le Pen victory
  • Polls for second-round match-up shows Le Pen trailing by wide margin
  • Germany-France 10-year spread is the widest since 2011-12 Eurozone debt crisis
  • Pressure is also building in Germany, where Merkel's CDU faces a stiff challenge
  • A defeat for Merkel is unlikely to be mourned in debt-laden Greece 

French political posters
 The French presidential race is just one instance of political upheaval
across Europe this year. Photo: Shutterstock

By Michael Boye

Just as the Eurozone enjoys a big wave of optimism that west European economies could finally break free of the lacklustre slow growth that has trapped them for years, suddenly political upheaval and instability seem to be threatening everywhere in the region.

Europe looking to break years of economic deadlock
Eurozone
Source: Bloomberg 

It may have started with the Brexit referendum last summer, but this year the electorates of the Netherlands (March 15), France (April 23) and Germany (September 24) will vote in parliamentary and/or presidential elections. 

Furthermore, early general elections cannot be ruled out in Italy, which is seemingly notoriously prone to political instability, as it remains without a parliamentary leader after prime minister Matteo Renzi stepped down and recently left the political scene all together. In that case, two-thirds of all Eurozone voters could potentially cast ballots in 2017.

For now the immediate attention is fixed on the French presidential election, where the market has been anxious about the prospect of the populist candidate Marine Le Pen winning on the back of a protectionist platform similar to how Donald Trump was elected in the US last year. 

In a two-round election system, polls have so far indicated a marginal win for Le Pen in first-round voting, while the second-round match-up between Le Pen and either of the two likely opponents — left-wing candidate Emmanuel Macron and right-wing candidate Francois Fillon — has Le Pen trailing significantly, by 15-20 percentage points. 

Nevertheless, perhaps as investors refuse to be caught by surprise by another underdog, the spread between German and French 10-year sovereign yields has expanded to its widest gap since the 2011-12 Eurozone debt crisis. 

Trading normally at 20-30 basis points, reflecting the market's perception of scant added risk of a French default, investors are now able to pick up a stark premium of an additional 76 basis points – more than twice the size of the German 10-year yield of 30bps itself – for exposing themselves to the financial ruin of Paris rather than Berlin.

Spread between French and German government bonds widen to multi-year highs
France
 














Source: Bloomberg

Meanwhile, pressure is also building in Germany, where this weekend the opposition left-wing SDU party for the first time took a lead in the polls over 12-year chancellor Angela Merkel's right-wing CDU. Needless to say, this raises the prospect of a disruption for the Eurozone's political hub, where Merkel has been the one constant at the helm during unprecedented political volatility and crisis in the form of debt crisis, immigration turmoil and, most recently, the Brexit debacle.

One place where a defeat of chancellor Merkel might not cause a national day of mourning is Greece, where another bailout package could be needed to make sure the Greek government can make ends meet. The International Monetary Fund is protesting that a combination of further austerity measures and debt relief is needed to restore debt levels to sustainable levels. 

Athens has rejected further austerity point-blank, while Brussels has been a long-term opponent of debt relief. On the other hand, IMF support could be pivotal to ensure the fragile support for the bailout program prevails in national parliaments, especially amid this year's electoral volatility (as mentioned above). 

Investors betting on a peaceful solution to Greece's predicament would currently be able to bank 7.5% in annual yield on 10-year Greek government bonds – up from 6.4% in December. Clearly, bond investors across Europe are bracing for political volatility in the months ahead.

Greek government yields on the move, but still far from previous levels
Greece
 














Source: Bloomberg. Create your own charts with SaxoTrader; click here to learn more 

– Edited by John Acher

Michael Boye is a fixed-income trader at Saxo Bank

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