Volatility May Wilt as Election Expectations Take Root

Favourable European election results coupled with progress for the Republican growth agenda in the US could soften market uncertainty, says our Capital Markets and Thematic Research team. But for the next few weeks, the road still looks bumpy.

The geopolitical scene is about to get smoky and hot. Within the next few weeks, investors will have fresh information on a variety of risks that have dominated news headlines. The outcome will drive markets and set the course for the remainder of 2017.

In Europe, an election super-cycle kicks into high gear, as French voters go to the polls to select a new president. While the anti-euro, far-right candidate, Marine Le Pen, is positioned to win first-stage voting on 23 April, she probably won’t take an outright majority. This would mean a final, second-stage vote on 7 May, with one of the more establishment, market-friendly candidates – perhaps Emanuel Macron – winning. But as any President Trump supporter or Brexiteer will happily tell you, the polls can be wrong. And while France should take the main stage in Europe, nitty-gritty details on the UK-EU divorce should come to light, and Italian elections – where euro-sceptic parties are polling above 50 per cent – could be called at any time.

On the other side of the pond, the clock is ticking on President Trump’s first 100 days in office, which rumbles to a close on 29 April. Optimism about Mr. Trump’s pro-growth agenda has been a key factor supporting US corporate earnings, inflation expectations, share prices and the spike in “soft”, survey-based economic data like consumer and business confidence. But, despite running the presidency and both houses of Congress, things haven’t gone smoothly. President Trump has struggled with both self-inflicted injuries (like wiretapping tweets and Russia connections) and external obstacles (like high federal debt levels and fiscal hawks within his party).

The 24 March failure of the Republican initiative to dismantle President Obama’s Affordable Care Act may be an indication of future challenges to buoyant animal spirits. Governing is complicated. Gaining consensus around debt-financed initiatives like major tax cuts and USD 1 trillion in infrastructure spending might not be a slam dunk. Congress is scheduled to go on a two-week recess starting 10 April. On 28 April, the US government is scheduled to run out of the cash. Aside from side-lining the risk of a government shut-down, an agreement to extend financing – at least until later in the year when the debt ceiling again becomes an issue – would be an easy way to demonstrate that Trumponomics is alive and kicking.

Against this uncertain geopolitical backdrop, central banks around the world are struggling to balance massive monetary accommodation against a spurt in inflation pressures. Headline prices in the US, UK and Europe are already at or above 2 per cent. At the same time, seven central banks globally are still running negative interest rate policies, while aggregate global quantitative easing continues to expand at breakneck speed. Looking ahead, we think central bank liquidity – one of the factors that helped support risky assets during the post-crisis era – might peak by early 2018.

Today’s risk-takers should benefit if uncertainties fade amid favourable European election results and forward progress in the Republican economic growth agenda. But if risks veer into reality, earnings expectations – and thereby share prices – might start to look a little bit extended. As usual, we’ll know for sure when the rubber hits the road.

Greg Meier – Strategist, US Capital Markets Research and Strategy – Allianz Global Investors