Keep moving, please!
Five theories about the European election and its significance for the capital markets
Populists expected to become a stronger force
But no ‘takeover’ of the European Parliament
Instead, member states are the obstacle to greater Integration
The result: high volatility and persistent risk premiums for European assets
Forecasts for real gross domestic product (GDP)
Curiosity driven by fear
Today, we live on a continent that is both peaceful and prosperous. However, confidence in the longevity of its political mechanisms has faded in the wake of the events of recent years, whether Brexit, the refugee crisis or the Italian election. Many investors no longer take ever-closer integration as a given or assume that the process cannot be reversed. So the new-found interest in the European election is driven not by enthusiasm for the European idea but by fear: What would happen if the unity project were to fail?
Fire and water: populist politics almost anti-European by design
This fear has been triggered by recent developments. Populist parties have become a force to be reckoned with all over Europe, and this is extremely significant for the EU. Populist programmes are almost duty-bound to adopt a critical stance towards Europe, from a retreat into the domestic sphere to isolation and fragmentation. The core of right-wing populist politics therefore jeopardises key building blocks of the European Union. Even a partial return to the era of stand-alone national economies would be bad news for Europe’s prosperity and for the capital markets.
Importance of the European Parliament
From the perspective of investors, an increase in the strength of populist forces brings with it the risk of policies that are bad for the markets. But how likely are such effects in the context of the European election? In other words, what power does the parliament have over the markets? Five theories about the outcome of the election and its impact on the capital markets can be put forward.
Populist parties such as Lega Nord emerge from the election as a stronger force and try to exert greater influence on the European agenda. This would lead to increased political uncertainty and make political decisions more unpredictable, a combination that is likely to result in repeated phases of heightened volatility in the capital markets.
Concerns that populists will take over the EU Parliament are exaggerated. Although the latest polls show that (right-wing) populists will be the strongest force in the new European Parliament, the fragmentation of the individual parties and the embedding of the parliament within the institutional framework will prevent them having direct access to legislative processes. A crisis is therefore unlikely to emerge after the election, and that also applies to the capital markets.
The threat that populists will obstruct Europe emanates from the member states, not from the European Parliament. Member states often blame domestic failures on Brussels and block EU initiatives. This behaviour is likely to become more prevalent in the event of populist candidates being voted in. The European election will serve as a litmus test. In the bond markets, populist obstruction usually results in higher risk premiums, as was recently the case in Italy.
International investors are demanding a political risk premium. Investors from Asia and North America find European matters, such as the current debate about the European election, difficult to understand. The steady withdrawal of foreign capital from eurozone stock markets over the last 18 months and the markdowns on European equities relative to their international peers speak for themselves. Given the persistent uncertainties, the eurozone as an investment region will have to put up with lower valuations across all asset classes than those for similar investments in other regions.
Europe needs to batten down the hatches, as the period of economic calm is coming to an end. In the medium term, the parliament will have a crucial role to play as the pacesetter for the European project. If this does not happen or if the European Parliament is unable to perform this role adequately due to its political fragmentation, enthusiasm for projects such as the euro and banking union will most likely wane again.
Never try to catch a falling bicycle?!
Against this backdrop, the famous quote attributed to former European Commission President Jacques Delors becomes particularly relevant: “Europe is like a bicycle: allow it to stop moving and it falls.” This lack of forward motion is precisely what investors fear most with regard to the eurozone. Some investors do not want to catch a falling bicycle (figuratively speaking, of course) and are therefore staying away from the euro area. The recent decisions by Japanese carmakers to not produce certain models for the European market in either the United Kingdom or mainland Europe are a cautionary example. It is this situation that makes the ninth election in the history of the European Parliament so important for investors. After all, Europe needs political movement and a new direction if it is to remain economically successful and thus strategically attractive to investors. Both the European Parliament and the European Commission will have a vital role to play.
As at April 11, 2019