Does the market underestimate Eurozone risks? - Natixis

René Defossez, Research Analyst at Natixis, suggests that in many EU Member States, populist parties, generally eurosceptic, have surged at the expense of the large institutional parties and this change is a particular problem this year on account of the many upcoming elections: in the Netherlands (this week), in France (in April, May and June), in Germany (after the summer) and Italy (possibly in September).

Key Quotes

“In most countries, populist parties could do extremely well. In other words, there are objective reasons for being concerned about the future of the euro, as the PVV (Netherlands) and National Front (France) have made clear they want out of the European Union. At the level of the European Union, the White Paper published last week by the European Commission constitutes an acknowledgment that the Eurozone needs reforming if it is to survive. The UK’s scheduled exit underlines the lack of enthusiasm of many in Europe when it comes to European institutions.”

“Given this political environment, one would expect major strains in the markets. There are strains to be sure, but they are not exceptional.”

“In France, the turn taken by the election campaign ought to have rattled investors. Yet investors have remained relatively composed, especially if one considers current conditions in light of what they were during the previous election cycle.”

“In Italy, the political situation is complex to say the least: the current government does not command a majority in the Senate since the secession of the left wing of the Democratic Party. Technically, the government could fall at any moment (which is unlikely, however, in that the secessionists are opposed to the holding of snap elections). Nor does Matteo Renzi now appear very keen to have snap election (but the position of the former Prime Minister is still rather ambiguous).”

“Uncertainties shrouding the Eurozone as a whole could also have sent Euro swap spreads soaring to very high levels, especially when the European Central Bank is responsible for the dearth of German paper.”

“The market may be more serene, but this is not to say that it is serene. There is a big difference between the situation in 2011-2012 and what it is today: five year ago, the whole edifice looked on the point of collapsing, with spreads that were soaring just about everywhere. The sovereign debt crisis was at its zenith. The European Central Bank stepped in to shore up the foundations. Right now, the edifice is not vacillating and the current political risk won’t bring the house down all of a sudden. The risk that a populist, eurosceptic party will be swept to power in a European country remains slight.”

“In fact, the current risks are of another order and, especially, difficult to contain using monetary policy: if by an extraordinary turn of event a eurosceptic party is swept to power, it is the very existence of the Eurozone that would be in jeopardy. The European Central Bank can protect a sovereign debt under attack by the markets, but there is not much it can do to dissuade a Member State wanting to leave the Eurozone.”