The next election shock?

Markets are anxious about upcoming European elections, but Richard Turnill explains why near-term political risks are probably overstated.

Markets are anxious about several upcoming European elections, all featuring anti-European Union (EU) or anti-euro parties. Last year proved upsets can happen, but we believe European near-term political risks are probably overstated.

The Netherlands holds elections next week, soon to be followed by France, and later Germany and Italy. We are most focused on the outcomes in France and Italy, where populist parties could potentially gain power. Government yields there are up sharply, as evident in the chart below, with spreads at some of the widest levels since the eurozone sovereign debt crisis.

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Markets view France’s presidential vote as the next potential electoral shock. Populist candidate Marine Le Pen, who has flagged a referendum on EU membership and reintroducing the franc, appears poised to make it to the final round of the two-round voting system. Yet if she does, polls suggest she will likely lose, with a polling gap far wider than that seen ahead of the Brexit and U.S. election surprises. Even if Le Pen were to win, we believe she would have a hard time securing a majority in parliament, lowering the near-term risk of a eurozone breakup.

Italy’s shaky political outlook worries us more and should keep Italian bond spreads wider ahead of a likely late-2017 or first-half 2018 election. Italian populist and right-wing parties together garner about 45% support in a country where anti-euro sentiment is strong and majorities in parliament may be factious and fragile.

For now, we see upside for European stocks, albeit with volatility, as global reflation and stronger growth boost corporate earnings and some political jitters calm. We are neutral on European government bonds, as elections pose short-term downside risks, and we are growing more cautious on European credit. An easing of European political risk should result in higher yields globally, supporting our cautious stance on U.S. Treasuries. Read more market insights in my Weekly Commentary.

Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog.

Investing involves risks, including possible loss of principal. International investing involves special risks including, but not limited to currency fluctuations, illiquidity and volatility. These risks may be heightened for investments in emerging markets. Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of March 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

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