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Political uncertainty shuffles the deck and ruffles the markets

After the American elections and just before major elections in Europe (referendum in Italy on 4 December, general elections in France and Germany in 2017, then in Italy no later than spring 2018), uncertainty is the keyword (again). And that's not counting the negotiations between the United Kingdom and the EU over Brexit, which promise to be tense; no one knows where they will end up. Economic policy uncertainty indices offer an instructive measure of the level of uncertainty1.

Surprisingly, this index has quite plainly fallen back in the United States since the election of Donald Trump2 (the post-election peak was short-lived). It is probably related to the fact that President Trump and his team have softened the promises of Candidate Trump by setting aside the most controversial measures (building a wall with Mexico, immigration, and protectionism), seeming to focus on what gets the consensus, i.e. tax cuts. That's all it has taken to quash the uncertainty in America.

By contrast, uncertainty in Europe spiked in November. As expected, it remains highest in the UK, despite the publication of solid economic data in the third quarter. Surprisingly, within the Eurozone, uncertainty climbed highest in France, and even reached an all-time high in November. The French Republican primaries, and the US elections, have evidently played a role, and a growing number of observers (namely abroad) are taking seriously the possibility that Marine Le Pen will win the presidential elections. On the flip side, the Italian media don't seem excessively concerned by the result of the referendum: The uncertainty index scarcely budged in November, and is still far below what it was during the sovereign debt crisis, for instance.

Uncertainty indices are in no way predictive. They simply measure perceived reality at a given moment. However, they do help to take stock, after the fact, of the trends in certain financial variables: the rise in interest rates in the US, the 10Y spread between the US and Germany (which hasn't been this high since the late 1980s), the climbing dollar, the rising sovereign spread between France and Germany (50 bp), and the US equity market’s outperformance over its European counterparts (despite being relatively expensive).

Everything is happening as if there were a positive "political risk premium" on Eurozone assets and a negative "political risk premium" on US assets. This configuration is probably not meant to last throughout 2017. Sooner or later, Donald Trump risks reviving his demons (protectionism, immigration). Meanwhile, in France and Germany, the dominant parties' candidates will probably win the elections next year. Nonetheless, it is much too early to be counting on that sort of development.





BOROWSKI Didier , Head of Macroeconomic Research
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Political uncertainty shuffles the deck and ruffles the markets
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