Economic Data and Political Uncertainly Cause Market Rout

May 7, 2012 Updated: May 9, 2012

Economic Market Insight

AMSTERDAM—Last week saw the euro currency as well as European shares drop sharply among Greek and French election jitters and a slew of bad economic data.

The EURO STOXX lost 4.08 percent to close at 2,248 last Friday. The euro currency lost 1.28 percent, closing at $1.31. It was under pressure again during a late Sunday trading session yesterday as the first results of the Greek and the French elections were released.

French Election Confirms Socialist Candidate

As was widely expected, the Socialist candidate Francois Hollande won the French presidential election in a run-off vote against incumbent conservative President Nicolas Sarkozy who already conceded defeat.

Hollande captured 52 percent of the vote versus Sarkozy’s 48 according to late Sunday exit polls, and will be the first Socialist president since Francois Mitterand left office in 1995. Francois Mitterand rose to fame in 1981 when he moved to nationalize the 36 largest French banking institutions only four months after ascending to office.

Hollande is perceived by many market participants as being less bank- and euro-friendly than Sarkozy. Also, the partnership between Angela Merkel, Germany’s chancellor, and her new French counterpart will have to be redefined. Previously, Sarkozy and Merkel could work reasonably well together and despite limited long-term success formed an experienced team to counter immediate crises.

The Socialist Party president-elect on the other hand wants to change the EU’s fiscal compact; a program to reduce government deficits by including provisions for pro-growth spending. He also wants to separate retail and investment banks—echoing the U.S. Glass-Steagall Act of 1933. Other proposals include a 15 percent higher corporate tax for banks and up to 75 percent income tax for incomes higher than 1 million euros ($1.30 million).

Home to banking giants such as BNP Paribas and Societe Generale, this will negatively affect an already weak European banking sector. The European Bank Index is hovering just above all-time lows, having lost already 12 percent of its value this year.

Greek Election Adds Uncertainty for Future

There was still no official result for the Greek election at the time of this writing, but the most recent exit polls according to Reuters spell trouble for the fragile agreement that was reached in March when Greece entered the largest sovereign debt restructuring in history.

According to the latest exist polls, the two parties that would continue to support the agreement with the European institutions and continue on a road of austerity were the New Democracy and PASOK parties. New Democracy as center-right received 18.9 percent of the vote or 108 seats and PASOK as center-left received 13.4 percent or 41 seats. In order for the two parties to form a successful coalition government, they would need 151 seats. As the current tally stands, they only come to 149 seats and all other parties oppose continued austerity.

Alexis Tsipras, head of the left coalition Syrizia that won 51 seats in Parliament said: “Mrs. Merkel needs to understand that austerity policies have suffered a huge defeat,” making a reference to one of the architects of the Greek bailouts, German Chancellor Angela Merkel.

“With their vote, Greek people gave a mandate for a new dawn in our country with solidarity and justice instead of barbaric bailout measures,” Tsipras said.

Tsipras represents a party at the left, but not at the margin of the political spectrum. Other parties on the far end of each political spectrum that will very likely make it into the Parliament include the communist party, which favors an outright euro exit and the ultra-right Golden Dawn with extremely nationalistic overtones.

It is hardly good news for the financial markets that EU policymakers will now have to fight different political battles, while they have a full-scale economic crisis at hand. Tensions were already on the increase before the election with German Finance Minister Schaeuble on record last week, “If Greek voters were to vote for a majority that does not honor those agreements, then Greece will have to bear the consequences of that.”

Economic Data Disappoints as ECB Leaves Rates Flat

European Central Bank (ECB) President Mario Draghi echoed market sentiment when he said that there are still “downside risks” to economic outlook. Despite the fact that the ECB left rates unchanged, he did confirm that the central bank has potent tools available to act firmly and in a timely manner.

Meanwhile the data for 2012 suggests nothing but a slowdown. European Purchasing Manager Indices disappointed heavily, dropping from 47.9 to 46.9 on expectations of an unchanged print in April. The forward-looking series records corporate purchasing managers’ sentiment and a reading above 50 indicate economic expansion.

Unemployment data out of Germany was also worse than expected with an increase in jobless claims of 19,000 instead of a decline of 10,000. The unemployment rate for Germany is still very low at 6.8 percent, but there would be dire consequences if it were to roll over as other countries are not in such fine shape: Italian unemployment rose to 9.8 percent as total eurozone unemployment increased to highest print on record of 10.9 percent.

The Week Ahead

Bond auctions this week will include Germany, Netherlands, and Austria, the safer countries in Europe. The only upset imaginable is that scary investors are willing to pay a negative nominal yield for German bonds. Belgium, a more questionable issuer, is also coming to the market on Friday. The country has so far been under less scrutiny thanks to the focus on Spain, but could well become one of the next sources of instability.

Important economic releases will come from Germany after this week’s disappointing PMI miss. The country will report the lagging industrial production and factory orders series for March. While the data series is backward looking, it can serve as confirmation for developing trends, such as a renewed slowdown in Europe.

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