European economies hit by rise in political uncertainty

Over recent quarters, European economic and financial market performances have suffered in relative terms more than other regions. In spite of sizeable efforts made by the European Central Bank, which is specifically targeting the support of domestic demand via the credit channel, European risk assets have underperformed recently. 

Since Mario Draghi’s announcements four weeks ago, those assets that would have been expected to benefit have been lagging significantly: the banking sector in the Eurozone is down 12%, while peripheral stock market performances have also suffered (FTSEMIB -6% and IBEX -5%) as the EUR rose sharply and political uncertainties continued to rise. In other words: in order to unlock the performance potential of European risk assets, we probably need a perception of falling economic policy uncertainty. It is probable that this will not occur before the EU membership referendum in the UK. 

More precisely, slowly improving European macroeconomic data are being offset by the rise in various political risks, among which we can list the following, in order of importance, for the financial markets: 

• Brexit risk. While the outcome of the referendum on EU membership on June 23^rd remains too close to call, according to polls, market-based measures of Brexit risk (e.g. GBP weakness vs. the euro, UK CDS spread vs. Germany) have crept up since the start of the year
• Refugees. Efforts to reduce the migration flows on the EU’s borders are being stepped up thanks to an EU deal with Turkey but could be jeopardized by the opening of new routes. The number of asylum seekers in Germany has fallen from close to half a million in Q4 2015 to 170k in Q1 2016, of which 20k in March
• Hiccups in the negotiations on the next bailout tranche for Greece
• Terrorist attacks. Just four months after the attacks in Paris, the Brussels bombings have renewed fears of perceived insecurity for many Europeans living in urban centres
• Gridlock in Spain. The political vacuum in Spain since the general elections on December 20^th, 2015 could well lead to a new election this summer (with opinion polls indicating little change compared to the outcome in December)
• Dutch referendum. Although turnout amounted to just 32%, an overwhelming majority (64%) rejected closer EU links to Ukraine in a referendum in the Netherlands

Rise of political uncertainty in Europe
(Index of media coverage, 3m mov. avg.)

Sources: www.policyuncertainty.com, Candriam AA Strategy

FX-implied Brexit probability and CDS

Sources: Bloomberg, UBS, Candriam Asset Allocation Strategy