Kathleen Brooks | Sep 25, 2017 11:52
The rise of the far-right AfD party at last weekend’s German election has grabbed the headlines, but as we said in our earlier note, Merkel remains as leader and the far-right will not have power even if they have won a seats in the Bundestag.
The market reaction is still mild, the Dax has rebounded after earlier gapping lower, while the euro remains weaker but EUR/USD is still holding on above last week’s low of 1.1862.
Populism rocks Germany’s markets more than France
The populist risk is still alive and well in Europe, as Germany’s election result makes clear, however the contrasting market reactions to the French and German election results is quite puzzling. Marine Le Pen, the leader of the Far Right in France, won a third of the French vote, while the AfD won 13% of the German vote, yet the CAC 40 surged nearly 10% after it became clear that Le Pen would not be able to win the French Presidency, this is in contrast to the muted market reaction to Merkel’s win in Germany. The logic behind this muted reaction is possibly to do with the huge rise in the euro this year, and the surprising decline in support for Angela Merkel is a perfect excuse to sell the euro at this elevated level.
Spain, and why referendums tend to be bad news for a currency
But, even if we see a Merkel-inspired dip in the single currency, we still expect it to be relatively muted, with a move back to $1.1650 – the mid-August low- a potential possibility to the downside. However, the bigger risk to the euro is unlikely to come from Germany, but instead could come from Spain where the Catalan region is planning to hold an illegal referendum on independence on 1st October. The referendum has been deemed illegal by the central Spanish authorities, yet this has seemingly emboldened the separatist supporters, who are vowing to distribute 1 million ballots ahead of Sunday’s vote.
The risks of the Catalonia vote include:
This vote has also triggered an increase in Spain’s yield spread with German bond yields, as you can see in the chart below. In the past, an increase in peripheral yield spreads has spurred higher volatility in European share prices and in the euro. Although the Spanish-German yield spread is nominally low, if it continues to move higher then we could see it become a risk factor for European asset prices in the coming days.
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