"We have been working on a trade deal which will be a very, very big deal, a very powerful deal, great for both countries and I think we will have that done very, very quickly."
–President Trump at last weekend’s G-20 Summit in Germany on a U.S. - U.K. trade deal.
I’ll open this missive paying respect for the title to Erich Maria Remarque’s seminal World War I book, and, yes, I’ll juxtapose it with President Trump’s utter optimism on crafting a trade deal with the UK. Now only if the Europeans had similar sentiment about their own (future) trade deal with the UK! (wink, wink)
But, as they say, the devil is in the details? And one only needs to marginally follow the Brexit headlines to know that leaving the EU has been a huge European political and legal football. Any resolution on a new trading agreement (at least with the EU) is unfortunately likely to be counted in many more months (perhaps years), not weeks.
As it relates to Europe, our macro team is fresh from introducing our Q3 Macro Themes (a replay of our 6/30 call for subscribers can be found HERE), and one of our three themes includes #EuropeSlowing?.
In the presentation we detail our view that we expect European growth and inflation to slow in the back half of this year and outline a contrarian position to the current market view to own European stocks and the Euro.
I encourage you to listen to the 60 minute call if you haven’t already.
Back to the Global Macro Grind…
Notwithstanding the inherent risks associated with Brexit and ECB policy maneuvering, below we detail three key country elections (Germany, Austria, and Italy) over the next 6-9 months that could impact European (and global) assets.
German Elections – With the German general election set for September 24th, what 5 months ago in February looked like a dead-heat showdown between Chancellor Merkel and her Christian Democratic Union (CDU) and its sister party Christian Social Union (CSU) vs Martin Schulz of the Social Democrats (SPD), is now anything but. Chancellor Merkel has materially pulled ahead, poised for her fourth term as Chancellor, with opinion polls showing a 13-16 point lead over her nearest competition, Schulz.
What changed over the past 5 months? Two main points are worth consideration:
- President Trump shifted foreign affairs to the top of the agenda, a strong suit for Merkel. Prior to this shift, Merkel’s support took a great hit due to her domestic handling of immigrants into Germany (essentially an open door policy) that left many cities and towns over-crowded with migrants with no shelter and direction on their status, and
- The SPD was dealt a crushing defeat by Merkel’s CDU in May in a state election in North Rhine Westphalia, a historic SPD stronghold. This defeat dented Schulz’s and the party’s credibility to lead.
Assuming Merkel’s popularity holds up, the big question remains who her coalition partners will be, as no German party stands to win an outright majority. The CDU’s favored partners have been the Free Democrats (FDP), a business friend party. However, support for the FDP has waned, which, depending upon how Merkel’s party fares, could force her hand to establish another “grand coalition” with the SPD. Unfortunately a grand coalition between conservatives and socialists would likely leave Merkel’s hands tied domestically and internationally.
It’s worth calling out that the right-wing Alternative für Deutschland (AfD) party has had fits and starts of attraction over recent years, but has waned since it parted with its charismatic leader, Frauke Petry. In any case, no German party is willing to work with AfD. Finally, the Green Party and the far-left party (Die Linke) remain coalition options (albeit controversial) should Merkel want to build a three-way coalition, an option on if the CDU + FDP doesn’t claim a majority and she turns down a grand coalition.
Taken together, a Merkel win with the FDP appears to be the best outlook for a pro-market government, and any coalition government in the next German election will be pro-Europe and therefore pro EURO.
Austrian Elections – Austria is set to elect the next Wunderkind on October 15th! 30 year old Foreign Minister Sebastian Kurz was elected leader of the center-right Austrian People’s Party earlier this month, paving the way for him to become Chancellor following the collapse in May of the grand coalition between the Social Democratic party of Chancellor Christian Kern and the People’s Party.
Kurz has shifted the party further right, promising to reduce social benefits for immigrants, stop migration from the Middle East and North Africa into Austria, cut taxes and more efficiently spend taxpayer money.
While far right candidates in France (Marine Le Pen) and the Netherlands (Geert Wilders) did not get their parties elected this year, Austria’s People’s Party looks poised to become Austria’s next ruling party. While Kurz has not called for exiting the common currency (EURO), a “we’ll do it our way” leadership approach could spell marginally less support of the EU and Eurozone projects.
Taken together with an Italian push to the political right (more below), the two countries alone represent a sizable population, about 70 million, potentially shifting allegiance away from the values of the EU. (Italy is has the 4th largest population in Europe at 61 million; Austria’s population is just under 9 million).
Italy Elections - Could Silvio Berlusconi make a political come-back in the general election slated for the Spring 2018? In recent weeks he suggested he’s the driving force behind his center-right Forza Italia party and its allies (including the anti-immigration Northern League) triumphing in local elections across the country. For context, in late June of this year center-right parties scored victories in more than 100 Italian towns and cities across the country, raising wonderment if similar results could be achieved at the national level next year.
Berlusconi recently boasted that he had given 46 television interviews during the most recent campaign, saying: “I’m back, and you can see the results… if we remain united, we will win the general election. And we will do so with a program that I’m drawing up and will make public soon.” #BungaBungaParty?
It’s unlikely that the 80 year old former Prime Minister, businessman, and billionaire will return to office – he was banned from public office for at least six years in 2013 after being convicted of tax evasion—but stranger things have happened and Berlusconi had a history of influencing with his money.
For a country with some 64 changes in government in 70 years (most recently PM Matteo Renzi was ousted following the loss of a political referendum in December 2016), political instability has unfortunately become the norm.
Nevertheless, next year’s election could mark a key risk precipice and turning point that the market is underappreciating: a swing to the right, including any coalition government with Berlusconi’s Forza Italia, the an anti-euro party Five Star Movement, and the anti-immigration Northern League could send shock waves to the Eurozone project and therefore European (and global) markets, creating a “who’s next” Exit tumble weed of fear and uncertainty should the Eurozone’s third largest economy leave the bloc.
Could the results at the local level portend voting at the national level? Will markets have another Frexit (the threat and fear associated with France exiting Eurozone on a Marine Le Pen victory)? It appears very probable!
Good luck out there today,
Matthew Hedrick
Europe Macro Analyst
