Are European Bonds Signaling Another Imminent Crisis?

The rise of a new political class represents the failures of regional governments over the last four plus years.

As the number of crises facing the European Union and more specifically the Euro Area mount, the epicenter of the next crisis may surprisingly be the core of the constituents that bind these nations together.

While the focus on political upheaval has predominantly centered around France after the gaffes from the Republican candidate, even Germany is facing its own version of turmoil as Social Democrats storm into the lead in polling while a far-right nationalist threatens Dutch political incumbents.

The changing attitudes are most clearly reflected by financial markets

The changing political dynamic across Europe was not necessarily unforeseen, and reflects to a large degree disenchantment with failed immigration policies, lacking fiscal stimulus, and politicians who have simply lost the confidence of their constituencies.

The changing attitudes are most clearly reflected by financial markets, which are now pricing in a greater possibility of a Euro Area breakup. French spreads to German bonds are at the widest point since 2012 in a sign that investor sentiment is quickly worsening despite the ECB parroting the triumphs of monetary policy.

Riding the Tidal Wave of Populism

While incumbent politicians from across the Euro Area have become increasingly entrenched in defending the principles of the monetary union along with a failed approach to immigration, their limited focus has emboldened nationalist movements across the region.

In France, the evidence of this momentum is clear as Marine Le Pen’s National Front gathers momentum, now polling well ahead of all other major parties in the race. Even if she does not win the second round of voting, her party will play an important role in shaping the future of French politics.

Le Pen has been very effective at harnessing this anger

At a time when immigration policy has become a contentious issue, Le Pen has been very effective at harnessing this anger, especially after a serious uptick in terror-related incidents. Le Pen’s rise has made financial markets especially uncomfortable, as evidenced by rising French bond yields relative to other Euro Area members.

In the case of yield spreads, French sovereign debt yields are now at the widest point relative to comparable German yields since the last debt crisis. Although Germany is not necessarily immune from the political forces encircling Europe’s biggest economies, the spreads do suggest that Le Pen’s anti-EU rhetoric is troubling investors to such a degree that they require a significant enough discount to consider buying French debt.

However, France is just one example. The rise of Geert Wilders in the Netherlands reflects similar sentiment and growing backlash towards unchecked immigration policies.


Europe’s Core on Verge of Combustion

The rise of the new political class is clearly the best reflection yet of the failures of regional governments over the last four plus years. Although cautious to draw parallels to the Great Depression and the 1930s, it provides one of the best historical template for how economic crises turn into political crises and eventually result in war.

In the case of France, a period of prolonged high unemployment, weak growth, and fiscal austerity have exacerbated economic tensions. Although immigration may not be at the core of France’s problems, it presents a very useful scapegoat for politicians looking to drum up support.

Austerity generally is an easy way to give rise to more extremist political viewpoints

In France, current President Francois Hollande’s absence of any true structural reform and fiscal stimulus has become the Achilles heel of his administration. Austerity generally is an easy way to give rise to more extremist political viewpoints, France being no exception in this case.

With unemployment at 10.00%, Le Pen has been able to easily capitalize on the economic furor and failed immigration policies by presenting a different path that would eventually mean an exit from the Euro Area and European Union.

Although her rhetoric and plans are not necessarily in France’s best interest considering it remains among the least competitive European economies, to most voters it appears to be a viable alternative to a non-operational status quo.

Political Dysfunction Opening Door for Fringe Elements

The pervasiveness of political intractability across the Euro Area has created a sense that the common goals of the monetary union are now coming secondary to sovereign interests. Investors are almost certainly taking note of these developments, selling bonds of core countries like France, Spain, and Italy while buying bonds of countries viewed as having a more stable outlook such as Germany.

Alexis Tsipras, Greek Prime Minister

During this round of crisis, Greece may not necessarily be the fire, but potentially the spark that lights the tinderbox of political disaffectedness. In effect, it is the fault of sovereign leadership, which have failed to learn the lessons of history when it comes to effective governance.

Looming large over the Europe are the black clouds of change. After having swept up the UK populace, the next target is mainland Europe. The nonexistence of policies designed to promote growth instead of austerity has brought Europe to the political brink.

As bond yields, especially in France are now showing, this degree inflexibility is ripening the conditions for a very hostile downturn in economic fundamentals if left unchecked. Despite the best efforts of the European Central Bank, change for Europe is rapidly approaching, and likely not for the better.

Idan Levitov
Idan Levitov, AnyOption

This article was written by Idan Levitov, VP trading for Read more by Anyoption here.

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