We see a low risk of Europe’s populist parties winning power near term but expect them to stay on the political radar screen. BlackRock’s Richard Turnill explains, with the help of this week’s chart.
Key European political events are now in focus as investors look for another potential populist backlash. The Italian constitutional referendum on Dec. 4 comes as the conservative candidate in France’s presidential election next year is being finalized. This week’s chart helps explain the market backdrop.
Deeper structural problems are the backdrop to Europe’s political challenges. As the chart shows, investors have shunned eurozone banks relative to global counterparts. Italian bond yields have risen versus German yields before the referendum, yet the narrow spread also highlights the European Central Bank’s (ECB’s) efforts to calm the 2010-12 debt crisis and revive growth.
Stagnation fuels populism
Italy’s referendum as well as presidential elections in Austria and France should show whether populist parties are gaining greater sway. Election polls have wrong-footed investors this year, yet we see a limited risk of populist governments arising.
Polls currently suggest the Italian referendum, supported by Prime Minister Matteo Renzi, is likely to be voted down. Any Renzi resignation afterwards should result in a caretaker government that is likely to focus on reforming Italy’s electoral law. A yes vote could spark a brief relief rally in regional bonds and bank shares, in our view. We see a strong “no” vote delaying any fixes to the country’s sick banking system and emboldening populist parties. In France, polls show the successful conservative candidate for president as the favorite in any contest with far-right populist Marine Le Pen in the final round next May.
Even if populists don’t win now, the economic stagnation and political frustrations driving their rise are still at play. Europe’s leaders face other big challenges: managing Brexit, the anti-trade backlash and the migration crisis.
We expect investors to remain pessimistic on Europe relative to upbeat U.S. reflation prospects. We are neutral on European government bonds and favor investment-grade debt due to the ECB’s ongoing purchases. We are underweight European equities on concerns about the growth outlook. Read more market insights in my Weekly Commentary.
The iShares MSCI EMU Index ETF (BATS:EZU) closed at $32.79 per share on Tuesday, up $0.38 (+1.17%). Year-to-date, the third largest European equity focused ETF has fallen 6.42%.
This article is brought to you courtesy of BlackRock.