Political risks subside in Europe, but Yen hits new low

The markets have had trouble digesting election risks in Europe and the US this week, however, as we move to the middle of the week, they seem to have made up their mind. The worst fears about the French election seem to have subsided, concerns about the UK election tomorrow do not appear to be disruptive to markets, and even the disarray within the Democrats campaign in the US and whether or not Joe Biden will continue as their nominee is no match for the dominance of the US stock market. European markets have opened higher on Wednesday, the spread between 10-year French and German government bond yields has dipped below 70 basis points for the first time since mid-June, and EUR/USD is back above $1.0750. While political risk fades, FX risk is rising, after USD/JPY rose to within a whisker of 162.00 earlier today.

The Yen’s perpetual problem, and why the Japanese authorities won’t intervene

The yen continues to grind lower, and the weaker than expected Jibun bank manufacturing and service sector PMIs for June may have added to the downward pressure. This pair has fallen short of surging past the 162.00 barrier, however, if it does that could raise fears about official Japanese intervention. However, there is a Bank of Japan meeting on July 31st, where the market is pricing just less than a 50% chance of a rate hike. While a rate hike from the BOJ this month seems unlikely, if the BOJ really wants to boost their currency, slowing down their bond purchases is a good place to start. The rapidly declining yen could add pressure to the BOJ to cut their bond purchases when they meet at the end of this month, which could see excess USD/JPY volatility.

US Treasury market risk rises to 3-month high

US politicial risk has not stopped the S&P 500 from reaching a record high, US Treasury market volatility is on the rise, and is at its highest level since April, according to the ICE BoA MOVE index, of Treasury market volatility. Since the dollar tends to appreciate when yields move higher, we could see more upward pressure on the dollar, which may also put the Japanese authorities off intervening at this stage.  Fed chair Jerome Powell was deemed to be dovish when he spoke at the ECB central bankers conference in Portugal on Tuesday. US interest rate cuts could be the best tonic for the yen.

The bar rises for Marine Le Pen to win power in France

There are two factors boosting European equities right now:

1,Stronger PMIs for June. The service sector PMI was revised up to 52.8 from 52.6, and the composite PMI was also revised higher to 50.9 from 50.8 in May.  

2, Signs that the Far Right may struggle to win an outright majority in the French election, after the declaration of candidates for the second round of voting on Sunday closed to the public. Over 200 candidates have withdrawn from the second round race as  Republican Front tries to thwart Marine Le Pen’s far right’s chances of winning an outright majority. The French newspaper Le Monde, estimated that 218 candidates have withdrawn, 130 from the left and 82 from Macron’s camp. Marine Le Pen has said that her party would only go into government if it can act, but that it would try to make up any shortfall by joining with other candidates from the right. The problem for Le Pen is that the Republican front’s electioneering has worked, and so the bar for her party to win a majority or even form a coalition this Sunday has become much higher. This is boosting a recovery rally in French stocks and bonds.

UK: Political stability could boost FTSE attractiveness

The UK also saw an uplift in PMI reports for April, the service sector reading rose to 52.1 from 51.2 in May, and the composite PMI for June rose to 52.3 from 51.7. As mentioned, the UK election has not caused ructions in UK asset markets. The question now is, will the markets put actual faith into Kier Starmer and Labour, and help UK stocks catch up with their global rivals from a valuation perspective? Growth friendly policies and closer relations with the EU might just do the trick. The FTSE 100 was one of the best performers in Europe in Q2, rising approx. 3% on a currency adjusted basis, however, this was nearly half the level recorded by the S&P 500 and a third of the performance recorded by the Nasdaq. In the last five trading sessions as we lead up to the UK election, the FTSE 100 has lagged global indices, with big declines for GSK, Anglo American and United Utilities. GSK is battling domestic issues, while United Utilities may be selling off due to the risk of greater regulation for water companies from a Labour government. Encouragingly, banks and home builders are performing well this week, which is a sign of faith and health in the UK market.

High hopes for UK market

Once the election is out of the way, the question for investors will be if a stable political backdrop in the UK could entice investors to increase their stake in UK equities. Could it also encourage more firms to list in the UK if there is political discord in the US? For the first time in recent memory, ahead of this election, there are high hopes for the UK stock market’s future.