Markets rally like it is November 2016

European stock markets have opened marginally higher on Tuesday after Macron-mania swept over global markets at the start of the week. We expect there to be further upside, particularly if Macron can maintain his decent lead over Le Pen in the run up to the second round vote on 7^th May. However, if his lead over Le Pen starts to narrow then we could see nervousness and volatility return with a vengeance. Markets are vulnerable to polling risk now that investors’ have restored their faith in the French pollsters, and the polls leading up to round two of the French vote will be key market drivers.

The US also joined the party on Monday with the Nasdaq breaking a fresh record high and the S&P 500 a mere 1% from its record close in late February. Markets have a tendency to rally when their preferred candidate wins an all-important election, such as they did post President Trump’s victory in November in the US. Post-election euphoria lasted for about 4 months’, however, after that policy implementation risk set in, which caused US stocks to flat line. The same could happen to European markets if Macron fails to deliver on his election pledges.

Policy implementation risk could halt equity exuberance

Equity markets are putting a lot of faith into Macron, he first has to win the second round of the French Presidential election and get the keys to the Elysee Palace, but then his newly formed party has to do well in the National Assembly elections in June. Once the election sugar rush has faded, French bond yields.

French banks have been the immediate beneficiaries to Macron’s strong showing in the first round of the vote. Societe General, BNP Paribas and Credit Agricole rose 9.5%, 7.5% and 10.8% respectively on Monday. This is to be expected, as they are most correlated to the economy and are likely to salute a pro-business Presidential candidate. However, they are also most at risk if Macron’s En Marche! Party do not get enough seats in the National Assembly elections in two months’ time, which would make it hard for Macron to get his pro-growth agenda into action. Thus, European political risk is not at bay completely.

EUR/USD: looking past Macron Mania

This same longer term risk applies to Europe’s periphery, including Portugal and Italy, who saw their share prices rise substantially, and their bond yields fall at the start of the week. While we think that equities and bonds could rally further (bond yields fall), as the markets experience a period of rebalancing back towards Europe and potentially out of the richly-valued US market, the FX market is already cautious about Macron’s longer term chances. EUR/USD failed to get back above the 1.09 level on Monday, although it is rallying on Tuesday back to a high of 1.0888 at the time of writing.  If we can’t break above the 1.0937 highs from Sunday night then Macron mania may have come to an early end in the forex market.

The problem with the yen

The driver of the spike higher in the euro this morning appears to be momentum, as EUR/JPY regains the 120.00 handle. We think that the yen is particularly at risk right now, not only is USD/JPY testing the critical 110.00 level (a break above this level would be very bullish), but the prospect of the yen’s safe haven status could be at risk in the longer term if tensions between the US and North Korea/ China heat up. If this happens then the yen could get caught in the cross hairs due to Japan’s physical proximity to the crisis. This could be why we have seen the Swissie outperform the yen in recent days. The chart below shows the spread between the trade weighted CHF and the trade weighted JPY. After a period of yen outperformance from mid-March until mid-April, as North Korean tensions have heated up, the Swissie has started to outperform. Thus, going forward the Swiss franc could be investors’ safe haven of choice, at least for as long as the North Korean crisis continues.

Figure 1:

FTSE focus:

The FTSE 100 is just about managing to cling on to positive territory today, although a pullback is to be expected after Monday’s exuberant start to the week for risk. There were broad-based gains for the UK index yesterday, although Whitbread and Anglo American were the biggest losers. Materials and consumer discretionary are the weakest FTSE 100 sectors today, while healthcare and energy are leading the pack. Energy companies Centrica and SSE are in recovery mode today, however they still haven’t managed to claw back all of Monday’s losses after the Tory party pledged to cap standard variable energy tariffs if they win next month’s election. This highlights the dangers posed by political risk – it can impact the market in both directions. Analysts ultimately expect energy companies to raise the price of fixed price energy deals to combat any politically enforced changes to other tariffs, which could ultimately push up energy prices and further hurt an already beleaguered UK consumer.