There was a huge sigh of relief among investors when it became clear that
the populist-nationalist wave that ostensibly led to Brexit and Trump's
election was not going to sweep through Europe. The euro gapped
higher on April 24, and it has not looked
back. We have suggested that with the outcome
of the German election, European politics shift from tailwind to headwind.
Spain's most serious constitutional crisis in 40 years appears to have
climaxed this week. The business and political elite came together to
resist the secessionist pull of Catalonia. Other European countries, including
Germany and France, as well as the EU, defended the territorial integrity of Spain.
Although the crisis may linger into next week, Spain's assets began
recouping some of their recent underperformance.
The political focus is already shifting within the eurozone. In
Italy, the Chamber of Deputies finished today its third vote on the electoral
reform. The bill now goes to the Senate, which is unlikely to take it up
for several weeks. Next year's budget is a more pressing issue.
Still, the Senate is likely to approve the bill before the end of the
year. While this makes possible an election at the end of Q1, we suspect
it will be a Q2 event.
The new electoral rules favor
coalitions, and this was immediately seen
as a setback for the Five-Star Movement, which had ruled out forming a
coalition. Recent polls showed the Five-Star Movement running
neck-to-neck with the center-left
PD. There are suspicions in some circles that Berlusconi's forces may
have struck a grand bargain with the Renzi's PD that could involve not only the
electoral law, but the budget, appointments to some state-run companies, and
other issues. There seems to be some risk that no coalition or
block will secure a majority, which would leave the situation not too
dissimilar from the present.
Austria goes to the polls on Sunday. It may result in the first
European government to include the populist-nationalists. There is an
extenuating circumstance. The populist-nationalist Freedom Party served
in government 2000-2006 (and was ostracized by other European countries).
The center-right People's Party new leader Kurz (31 years old) has shifted to
the right, trying to outflank the Freedom Party on migration and response to
Islam. A columnist at the Financial Times compared Kurz to conservative
Austrian version of France's Macron.
The People's Party is drawing a solid third of the voters according to
recent polls, and the Freedom Party is in second place with a little more than
a quarter of the vote. The Social Democrats, which won the most votes
four years ago, is in third place with a little more than 20%. Although Kurz
was in government for six years, he has succeeded in running as an outsider,
forcing the Social Democrats to be identified with the status quo.
Social Democrat Chancellor Kern did himself and his party few favors with
the splintering of the party over the actions of a former adviser
(Silberstein). Under Kern, the Social Democrats approved the Berka
ban earlier this year. The full-face
veil, ironically, is not typically worn by women in the countries from which
the refugees in Austria typically come.
The Austrian election is important for more than another data point
in European political theme. In the second half of next year, an
important juncture of Brexit and post-crisis European evolution, and preparing
for 2019 when Draghi's term at the ECB ends, Austria takes up the mantle of the
rotating EU presidency.
While politics helps shape the policy framework, which in turn informs
the investment climate, the euro continues to prove fairly resilient to the
shifting political winds. The single currency has also been resilient
to the widening two-year interest rate differential with the US.
Germany's discount is over 220 bp, which is within two basis points to the peak
from March, which itself was the highest since 2000. A year
ago, speculators at the IMM were net short around 100k euro futures
contracts. Now they are net long 91k contracts. Implied volatility
is about one percentage point lower (three-month implied vol is now near
7.2%). The one-year risk reversal (skew between puts and calls) favor
euro calls for the first time 2009.
The euro's recovered in recent days after reversing higher at the end
last week. It was up four days in a row coming into today's
session. The recovery appears to have lost moment today near $1.1880, the
50% retracement of the decline since September 8. A move beyond the 6.18%
retracement (~$1.1930) would suggest another run at the highs. On the other
hand, a break of $1.1800 would boost out
confidence that this recent bounce was strictly corrective in nature, and would warn of a return to $1.1660-$1.1670 area, which we think
would be on the way to more formidable support near $1.16.