GLOBAL WEEKLY COMMENTARY

Gauging Europe’s political risks

28 nov 2016 / por Richard Turnill

Key points

  • We see a low risk of Europe’s populist parties winning power near term but expect them to stay on the political radar screen.
  • U.S. equity indexes hit records. The U.S. dollar index surged to nearly 14-year highs. The spread of U.S. 10-year yields over German yields touched a 27-year peak.
  • This week’s data on U.S. jobs and wages should reinforce the reflationary picture.

Key European political events are now in focus as investors look for another potential populist backlash. The Italian constitutional referendum on December 4 comes as the conservative candidate in France’s presidential election next year is being finalized.

Chart of the week
Eurozone banks relative performance and Italian government bond spreads,
2011-2016

Eurozone banks relative performance and Italian government bond spreads, 2011-2016

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) 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.

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Date: Event
Nov. 30 OPEC meeting, U.S. October PCE inflation and consumer spending
Dec. 1 Global November manufacturing PMIs
Dec. 2 U.S. November non-farm payrolls

Global PMIs should show the economic pick-up is broadening, highlighted by the eurozone flash manufacturing PMI hitting a three-year high in November. Another upbeat U.S. jobs report would focus the market’s attention on the number of Fed rate increases in 2017.

 

  • Major U.S. stock indexes hit all-time peaks, led by small-cap shares, on hopes Donald Trump’s economic policies would add fuel to growth. U.S. equities saw further inflows after a record week.
  • The U.S. dollar’s surge extended but emerging markets and commodity prices mostly proved resilient due to the global economy’s upbeat outlook.
  • Major government bond yields rose further. But the U.S. Treasury yield curve flattened as the market grew more confident of a Federal Reserve rate hike next month and beyond.

Global snapshot

Weekly and 12-month performance of selected assets

 

EquitiesWeekYTD12 MonthsDiv. Yield
U.S. Large Caps 1.4% 8.3% 6.0% 2.1%
U.S. Small Caps 2.4% 20.2% 14.2% 1.3%
Non-U.S. World 1.3% 1.9% -0.5% 3.2%
Non-U.S. Developed 1.3% -2.1% -3.3% 3.4%
Japan 0.5% 2.0% 0.9% 2.1%
Emerging 1.3% 10.0% 4.8% 2.7%
Asia ex-Japan 1.3% 6.7% 4.0% 2.6%
BondsWeekYTD12 MonthsYield
U.S. Treasuries -0.2% 1.1% 1.0% 2.4%
U.S. TIPS -0.2% 4.4% 3.5% 2.3%
U.S. Investment Grade -0.1% 5.2% 4.5% 3.4%
U.S. High Yield 0.5% 14.7% 12.0% 6.6%
U.S. Municipals -0.4% -0.1% 0.7% 2.6%
Non-U.S. Developed -0.4% 2.5% 3.5% 0.8%
Emerging Market $ Bonds -0.1% 8.6% 6.9% 5.9%
CommoditiesWeekYTD12 MonthsLevel
Brent Crude Oil 0.8% 26.7% 2.3% $47.24
Gold -2.0% 11.5% 10.5% $1,184
Copper 8.4% 25.0% 29.2% $5,879
CurrenciesWeekYTD12 MonthsLevel
Euro/USD 0.0% -2.5% -0.3% 1.06
USD/Yen 2.1% -5.8% -7.8% 113.22
Pound/USD 1.1% -15.3% -17.5% 1.25

Source: Bloomberg. As of November 25, 2016. Notes: Weekly data through Friday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Barclays U.S. Corporate Index; U.S. high yield by the Barclays U.S. Corporate High Yield 2% Issuer Capped Index; U.S. municipals by the Barclays Municipal Bond Index; non-U.S. developed bonds by the Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.

Asset class views

Views from a U.S. dollar perspective over a three-month horizon

Table: Asset class views from a U.S. dollar perspective

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Richard Turnill
Global Chief Investment Strategist for BlackRock
Richard Turnill is Global Chief Investment Strategist for BlackRock. He was previously Chief Investment Strategist for BlackRock’s Fixed Income and active Equities business and has also led the Global Equity team. Richard started his career at the Bank of England.
Richard Turnill
Global Chief Investment Strategist for BlackRock
Richard Turnill is Global Chief Investment Strategist for BlackRock. He was previously Chief Investment Strategist for BlackRock’s Fixed Income and active Equities business and has also led the Global Equity team. Richard started his career at the Bank of England.

Key Contributors

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Isabelle Mateos y Lago

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Kate Moore

Kate Moore

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Jeffrey Rosenberg

Jeffrey Rosenberg

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