Eric Stein, Co-Director of Global Income, Eaton Vance, a global investment manager, notes that markets have been seemingly impervious to negative headlines and volatility, but emerging political uncertainty in Europe might just test investors’ nerve.
Specifically, we are watching the ongoing stalemate over Catalonia’s independence and the populist movement gaining momentum in Italy.
Investors were able to put politics to the back of the mind over the summer following the euphoria after Emmanuel Macron defeated Marine Le Pen in the French presidential election. Additionally, markets focused on the economic strength in the Eurozone. But now, politics are back to the forefront.
In Spain, the Catalan president has decided to suspend the declaration of independence following the referendum vote on October 1, which only extends the period of uncertainty. Eventually, the dispute will be resolved with the likely outcome either the takeover of the Catalan government by the national government, or additional autonomy for the region.
While it will not likely result in independence right now, underlying tensions will likely remain.
In Italy, the strong support for the 5 Star Movement could potentially lead to higher political risk premiums in Italian assets, but it is unlikely that the party comes to power. A weak coalition is a high possibility with polls showing a fragmented landscape and a continuation of more of the same can be expected.
These two situations may create volatility in the near term, but both economies will likely be supported by the recovery in the Eurozone. An additional factor to watch will be ECB policy as it seems that the market is underpricing the impact that a reduction in purchases will have on the region.
The near-term uncertainty, combined with this shift from traditional politics that we are seeing across Europe, has made us more cautious on the outlook for the periphery.