By Dhara Ranasinghe
Anti-establishment votes in Britain and the United States have roiled markets twice this year and investors are determined not to be caught off guard again.
In 2017, voters in the Netherlands, France and Germany – and possibly in Italy and Britain too – will vote in elections that could be coloured by the triumphs of Donald Trump and supporters of Brexit, and the politics that drove those campaigns.
A litmus test for Europe is around the corner in Italy’s referendum on constitutional change on Dec. 4. On the same day, Austria holds a re-run of a presidential election in which one of the two candidates is from the far-right.
No wonder then, that in a general bond market sell-off since Tuesday’s U.S. election, some of the heaviest selling has hit France and Italy as investors brace for the potential of another anti-establishment drubbing in two big regional economies.
Top-rated German 10-year bond yields, which move in the opposite direction to the price, have risen about 17 basis points this week as investors bet protectionist policies and extra spending under President Trump will boost inflation.
But French and Italian equivalents have soared roughly 25 bps as investors also price in greater political risks. French yields are poised for their biggest weekly rise since June 2015 when a euro zone bond sell-off was at its peak.
“We’ve had an anti-establishment vote in the UK, one in the U.S. and now everyone’s looking at the euro zone and thinking, where do we have elections next year? Yes, France, so people are trying to zoom in on those countries that may be at risk,” said Martin Van Vliet, a senior rates strategist at ING.
France has a presidential system and the chances of Marine Le Pen, leader of the far-right National Front, winning are seen as slim. But polls suggest she will win more support than any other politician in the first round of the election.
Having been caught out by Britain’s shock decision to leave the European Union in June and Trump’s surprise election win, markets are unlikely to take polls for granted in the future.
Investors are also waking up to the fact that a populist tsunami that seemed unthinkable a few months ago has potentially huge consequences for Europe’s political landscape.
French 10-year bond yields, at 0.72 percent, are near their highest levels since January.
In a sign that investors have turned more bearish towards French debt, the gap or spread between French and German bond yields has widened to around 44 bps – levels last seen in July 2015.
As this graphic http://tmsnrt.rs/2fItTCG shows, similar moves have been seen in the Netherlands and Italy – other euro zone countries where the rise of populism risks upsetting the traditional order in looming elections.
It is not just bond investors that feel uneasy about a change in the political climate away from the status quo that often equates with stability for financial markets.
While any immediate fears over a rise in populism and protectionist policies in Europe have so far been overshadowed by a scramble to get in on the ‘reflation’ trade, European equities saw $1.64 billion of outflows in the week ending Wednesday, according to data from Bank of America Merrill Lynch.
Some analysts also argue that a recovery for the currency market’s 2016 whipping boy, sterling, points to growing concerns about upcoming elections in Europe.
“The UK Brexit vote will no longer be viewed as some kind of outlier vote but perhaps the beginning of a global shift towards more populist voting,” said Derek Halpenny, European Head of Global Market Research with Bank of Tokyo-Mitsubishi UFJ.
“The fall in the euro should then be viewed as a sign of a shift of the political risk premium from the UK to Europe.”
SPOTLIGHT ON ITALY, AUSTRIA
In addition to France, Italy — the euro area’s third biggest economy — is also feeling the heat of rising political uncertainty.
Trump’s unexpected victory in the U.S. presidential election is likely to make it even harder for Italian Prime Minister Matteo Renzi to win next month’s referendum on constitutional reform .
Renzi has said he will resign if he loses the ballot and almost every opinion poll over the past two months has put the ‘No’ camp ahead.
Against this backdrop, Italy’s borrowing costs at auction jumped to their highest in more than a year on Friday.
The gap between Italian and Spanish 10-year bond yields – a bellwether of political risk – is at 45 bps at its widest since the 2012 debt crisis.
“We really have to consider that the consensus and the conventional wisdom of the past two big elections have gone against the conventional wisdom and the expectations of the majority, and so that could certainly happen in Europe,” Chris Dyer, director of global equity at asset manager Eaton Vance, said.