Market Views

GLOBAL CREDIT BULLETS | Monday, 17 June 2024

Europe – Political risk back on the radar
President Macron’s decision to call early legislative elections (30 Jun and 7 Jul) triggered a re-pricing of political risk in Europe. The election will effectively be a race between three forces: Marine Le Pen’s National Rally (RN), Macron’s En Marche party, and a newly formed alliance that groups left parties from socialists to more extreme formations. The newly elected Lower House will be in charge of forming the government, including all ministries and the prime minister. Polls published on Thursday surprised consensus showing a solid majority for RN and the Left alliance tracking at second place. Markets repriced sharply on Friday, as the prospect of far right and extreme left being the main two forces in the country leaves uncertainty wide open.
The two main uncertainties pertain to the shape of the government and policies. On the former, a right-wing prime minister and “cohabitation” with President Macron seems most likely. A deal between the far right and the left seems unlikely, hence a strong result by the latter is likely to trigger a “rule by decree” status quo. President Macron seems unlikely to resign in any scenario, but his influence on policies will be reduced in all cases.
On policy, RN is likely to focus on less immigration and less taxes, while the left on more spending. As elections were called suddenly, a full electoral program is not available for any party. Both the new formations are likely to push for more fiscal expansion, and potentially less European integration, although no party discussed the European issue explicitly. We expect the volatility started last week to persist. European markets had a great 1H24 and positioning is long, especially in credit and a few segments of equity markets. On Friday, corporate spreads and equities repriced sharply, suggesting a quick increase in demand for hedges. France displayed a deteriorating deficit in 2024 and will likely go through an excessive deficit procedure. Pressure on the periphery is thus likely to increase, as markets re-focus on a risk that has been silent for almost two years. Ultimately, we don’t think the event will hurt eurozone fundamentals in a meaningful way, but the road to July 7 is likely to be bumpy.

Fed – From 3 to 1
The Federal Reserve held rates at its June meeting, as expected. Its own forecast of monetary policy was reduced from three cuts this year in March to just one. However, unemployment for 2026 was revised higher to 4.1%, and the central bank still expects five cuts into 2025. Powell sounded balanced, signalling an appetite to cut but patience on the data front. May inflation data, published Wednesday and Thursday last week, were supportive, pointing to a Core PCE in May around 0.1%, half of the April print. A September cut thus remains in play even if a December start is the most likely scenario.

Latam – Fiscal dance
Latin American markets turned very volatile over the past week as volatility in core rates compounded with concerns over local fiscal stories. In Mexico, uncertainty remains high towards a controversial reform that the new President may operate. In Brazil, market is sceptical about the government’s ability to cut spending and comply with fiscal targets. In Colombia, fiscal slippage creates doubts about the ability of the government to maintain a fiscal rule. While some fiscal deterioration took place in the three countries, the amount remains manageable (0.5% of gdp worsening in Brazil and Colombia). At the same time, all countries are showing a commitment to find a solution that stabilises markets. In Mexico, uncertainty is higher, but the fiscal balance is stronger. At the same time, valuations are turning extreme, especially in local bond markets. Real yields in the region vary from 7 to 9%, inflation is not increasing and close to central bank’s target, and spreads to US Treasuries are stretched. FX is also very cheap in Brazil. We see the current market volatility as excessive and see an opportunity in the region.

Algebris Investments’ Global Credit Team

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