France factored in, but Greece vote worries
05/04 07:37 AM
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FRANKFURT (MarketWatch)--Investors appear comfortable with expectations French voters will bid adieu to President Nicolas Sarkozy in Sunday's runoff election, but fear a potentially chaotic Greek parliamentary election on the same day could trigger renewed market turmoil next week, strategists said.
Polls have tightened somewhat, but still show Sarkozy trailing Socialist challenger Fran?ois Hollande by at least five percentage points as the rivals wrap up a final day of campaigning on Friday.
"If Hollande wins, we are going to see nothing change," said Jacques Porta, who helps manage 500 million euros ($658 million) at Ofi Gestion Privee in Paris.
A Hollande victory would be unlikely to further unsettle French equities or bond markets, Porta said, as investors realize he is constrained by the country's fiscal situation and the fact the country must work with its euro-zone partners.
Others still see the potential for conflict, and warn markets could eventually become unsettled.
While the market has discounted a Hollande victory, "this does not necessarily mean that there won't be a reaction in the longer-term. The key is whether Hollande really does push for some of the things he has campaigned for, such as a renegotiation of the fiscal compact," said Steven Barrow, currency and fixed-income strategist at Standard Bank in London.
"If he does it could clearly create tensions with Germany, which has suggested that the pact is not up for debate. And given that the Franco-German axis is so crucial for things like bailouts, a breakdown of this relationship could weigh heavily on bond markets and the euro," he said.
A Sarkozy upset, meanwhile, would be almost certain to trigger a knee-jerk positive reaction in markets due to lingering uncertainty over Hollande's likely path, particularly with parliamentary elections to follow in June, strategists said.
Hollande's campaign rhetoric, including a pledge to go to war against the world of finance and renegotiate the euro zone's fiscal compact, served to unsettle financial markets somewhat this year.
France's CAC-40 stock index has gained just more than 1% since the beginning of the year, trailing the German DAX index's rise of more than 12%, the U.K. FTSE 100 index's 2.6% gain and the pan-European Stoxx 600 Index's 4.4% advance.
France, which lost its AAA credit rating from Standard & Poor's earlier this year, has seen borrowing costs rise relative to other so-called euro-zone core countries.
The yield on France's 10-year government bond spiked up to 3.10% on April 23, the day after Hollande topped Sarkozy in the first round of the presidential election, but has since drifted down to 2.92%, according to electronic trading platform Tradeweb.
The yield premium demanded by investors to hold 10-year French bonds over German bunds has risen from around 0.85 percentage point in February to just below 1.3 percentage points, but remains off the high near 1.9 percentage points seen last fall as euro-zone debt fears peaked.
Investors have fretted that a potential clash with Germany's austerity-minded chancellor, Angela Merkel, could undo the Franco-German alliance and complicate efforts to resolve the euro-zone debt crisis.
Hollande, however, appears less likely to attempt to water down the fiscal pact, which aims to enshrine tougher budget rules across much of Europe. Hollande's camp has signaled he would move to complement the pact, which was effectively engineered by Merkel and Sarkozy, with growth-oriented measures.
European Central Bank President Mario Draghi, while eschewing the notion of near-term fiscal stimulus, has urged a coordinated push toward market and labor reforms as part of a "growth compact."
Merkel has signaled support for boosting the role of the European Union'sEuropean Investment Bank in funding infrastructure projects, an idea that has also been advocated by Hollande.
Some strategists argue that a push toward leavening austerity with growth-oriented measures could be a positive, as market participants appear increasingly worried that austerity alone has proved counterproductive in the periphery while raising the risk of political backlash and turmoil.
It appears "that voters in Europe won't put up with a fiscal pact without a growth pact," said Bill Adams, senior international economist at PNC Financial Services Group in Pittsburgh.
Elisabeth Afseth, fixed-income analyst at Investec in London, said "stirring things up may well be a good thing at this juncture, recent economic data has given some indication of how severe the downturn coming in the wake of the fiscal contraction can be."
"Fiscal consolidation, of course, has to happen, and there is no painless way out of current problems, but the risk is that the strict focus on austerity does not address the underlying problem," she said, in a research note.
But others see danger.
While Draghi has talked of the need for a growth compact, his remarks at the ECB's monthly news conference Thursday and comments by German officials make clear that neither the central bank nor Berlin are wavering in their call for euro-zone governments to maintain fiscal discipline, said Nicholas Spiro, managing director of Spiro Sovereign Strategy, a London consulting firm.
"While the credibility of fiscal retrenchment is being undermined by the scale of the downturns in southern Europe, the [growth-versus-austerity] debate is a spurious one given the diverging time scales of austerity and growth-enhancing reforms--we believe Mr. Hollande's economic thinking reveals a misunderstanding of bond market psychology," Spiro said, in emailed comments.
Investors are worried about a lack of growth in the euro-zone periphery, but that "does not mean that Keynesian policies would be well received by the markets," Spiro said, warning that any short-term fiscal stimulus would likely fan fears the crisis will drag on longer and undermine the German and ECB credibility.
Meanwhile, bigger dangers may lie elsewhere.
Greece's parliamentary elections carry the threat of chaos, while local elections in Italy could serve as a referendum on technocratic Prime Minister Mario Monti's push to overhaul the country's labor market.
Greek voters are angry. Polls show support rising for fringe left- and right-wing parties as voters seek to punish the mainstream conservative New Democracy and the center-left Socialists, known as Pasok.
"Greece is by far the bigger risk," said Heino Ruland, strategist at Ruland Research in Eppstein, Germany. "The fear is that a new government will undo the rescue package and exit the euro area."
Surveys continue to show an overwhelming majority of Greeks want to remain in the euro zone, but remain angry over additional austerity measures demanded as part of the country's latest bailout as unemployment rises beyond 20% and the recession deepens.
A New Democracy-Pasok coalition can't be ruled out, but if the two parties fail to win a combined total 151 seats in the 300-seat parliament, the Greek situation could get complicated, said Paolo Pizzoli, economist at ING Bank.
"In a political vacuum, the transversal antiausterity movement would be even more tempted to raise its tones, likely injecting extra uncertainty in the market, " he said.
