Monday, 7 May 2012
The elections in Europe largely had the outcomes expected last week. However, it did not come as any great relief to the markets. What was two days ago a potential political uncertainty is now a confirmed political uncertainty. This adds to the uncertainty created by the horrible data indicated by the “Flash PMI” numbers last week. It is interesting that the uncertainty only affects the stock markets and the Euro. All other kinds of risk assets are holding up nicely. It rhymes with our perception that this is a completely normal rotation between the asset classes, driven by a readjustment of growth expectations. It is confirmed by our proprietary risk indicators, which remain low. This is not a repeat performance of the 2011 market collapse.
Hollande won the French election and will now have to face the reality. That reality is a country with high unemployment, slow growth, slow productivity growth, and a twin deficit as both government and external balances are in minus. He will not be able to fix any of that with the economic program presented during the election campaign. Rumours are also that he will face a wave of redundancies from large French companies – companies that Sarkozy allegedly leaned upon to make them postpone firings until after the elections. His first foray into the international scene will be a visit to Berlin, where he will be reminded that agreements are there to be respected.
However, the EU commissioner for economic affairs, Olli Rehn, has already indicated that the pact could be interpreted in a more flexible way – which probably means that the budget targets will stand but that the deadline for their implementation. German Finance Minister Schäuble has spoken of Hollande’s need to “save face”.
What the practical outcome will be is still uncertain. My guess is that some kind of growth initiative plus a de facto (even if not official) delay in the deadlines for cutting the budgets.
The preliminary results of the general elections pointed to a hung parliament, where the parties behind the debt restructuring agreement command exactly half of the seats in the new parliament. A motley crew of parties opposing the agreement form the other half. For the financial markets the issue will be whether this will now lead to an actual default on the reduced government debt. It is too close to call, by my impression is that a weak coalition will be formed between parties in favour of staying inside the EU, and – by extension – to respecting the agreements. It may then survive a few months.
Local elections in the German state of Schleswig-Holstein gave an important pointer to the mood among Germans voters. Chancellor Merkel’s party experienced a slight loss, The main opposition SPD gained and most of the votes came from the minority partner in the current government, the liberal FDP. Merkel’s coalition is somewhat weakened, but mainly because of the plight of the coalition partner. So far it has no practical implications for her government.
What it means
All of this will probably keep the stock markets on their toes in the short term. There appears to be two main strands of thinking out there, and the market movements can be interpreted as result of the mood prevailing at any given mood. There are those who (still) believe that it is possible to cut one’s way to growth, and those who believe that excessive cutbacks will kill growth.
So far, the latter camp has been right. While nobody contests the necessity to increase budget discipline, it is obvious that Europe’s growth is tanking because of public sector cutbacks. And a lack of funding to small and medium-sized companies. We expect that the stock markets will remain jittery in the days to come and that EUR will continue to weaken.