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In a funny and admittedly narrow sense, this has been a great week for Europe.
With little fanfare but maybe a slightly satisfied grin, Greek Prime Minister Kyriakos Mitsotakis revealed that he intended to repay early some €8bn in emergency loans made out to the country in the depths of the Eurozone debt crisis, worth three years of instalments.
The country’s government bonds are back in business — its 10-year debt trades with a yield of about 3.6 per cent. The times of 20 per cent yields or more are an increasingly distant memory. Several rating agencies have taken Greece off the naughty step and handed back the prized investment grade labels that open the bonds up to slow-and-steady fund managers. The latest planned early repayment marks a show of strength and of confidence.
“The market seemed to believe our long-term goal story and also believe that this government is stable and here to stay in the long term,” Mitsotakis told Bloomberg.
By that measure, the Eurozone has come a long way since the grindingly grim test of cohesion and leadership thrown up by the debt crisis a decade ago, when the member states most heavily punished by the bond markets for their shaky public finances were rather unkindly bunched together as the PIGS — Portugal, Italy, Greece and Spain.
So that’s the good news. The bad news is that the region has a new cohort of problem children bugging markets. The even worse news is that they are the biggest kids in the room.
In late May, rating agency S&P Global downgraded French government bonds over fears about the country’s debt levels. Initially, the market styled it out, but then along came Emmanuel Macron. Political strategists are still debating whether the French president’s audacious move last weekend to call a snap election in an effort to correct the rise of the hard right is a stroke of political genius or a reckless gamble that could put his opponents in high places. It is hard to shake the memory of David Cameron calling a referendum on UK membership of the EU as a way to soothe strife within the Conservative party. How did that work out?
Investors are clear that they don’t like it. Lori Heinel, chief investment officer at State Street Global Advisors, quipped to me this week that FiGs are the new PIGS, now that France has hurled itself into disarray and Germany (the new G) has political and budget struggles of its own. We struggled to agree on the right I and S, but markets never let details get in the way of a good acronym.
“We have seen pressure on government bonds and on the euro,” said Heinel. Adding to the pain, Heinel said that “literally just before this, we added to our European [stocks] overweight pretty meaningfully”. Zut alors.
This, I suspect, is the case for lots of fund managers. With the European Central Bank now cutting rates and with some signs of economic stabilisation across the region, investors were growing more comfortable with loading up on European stocks, both as a diversifier away from the US and as a decent potential growth story in itself. As recently as May 20, Morgan Stanley declared European stocks to be “in the sweet spot” and raised its target for the MSCI Europe stocks index to 2,500, some 17 per cent above prevailing levels.
Now, that may still come true. The blow to markets so far has been clear but not severe, and could easily reverse on an election result in early July that investors like. France’s Cac 40 index has lost 6 per cent since being struck by Macron’s curveball and has now largely erased most of its previously quite handsome gains for the year. But it is not in freefall. France’s 10-year bond yields got close to 3.4 per cent at the start of this week but they have since backed down a little. Haven German Bunds have jumped sharply in price but we are not quite at panic stations yet.
We are, however, on high alert. “Fasten your seatbelt,” wrote Emmanuel Cau and his colleagues at Barclays. “The sentiment-driven pullback may look harsh but we advise caution. The campaign will be noisy. Outcomes are hard to predict and may be a source of higher medium-term uncertainty . . . Don’t rush to buy the dip.”
What is it that investors really don’t like here? As Barclays’ analysts spell out, the policy platform of Marine Le Pen’s Rassemblement National focuses on protectionism, state intervention and a clampdown on immigration which, in the bank’s view, “could lead to a significant increase in the public deficit and endanger European integration”.
The nightmare scenario that some investors fear is that an RN government in France would lead to something akin to the UK’s spectacular “Liz Truss moment” of bond market immolation in 2022.
This is all still up in the air for now. We don’t know how the French electorate will vote and investors are mindful that the right-wing leadership of Giorgia Meloni in Italy has been far from disastrous for Italian markets, as the country’s stable and sub-4 per cent 10-year bond yields show. But Macron’s wild card is something that previously upbeat buyers of riskier assets in Europe could have done without.
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