The French election is a game changer for global financial markets for multiple reasons. One: the worst case scenario of far right (Le Pen) and far left (Melenchon) as second round candidates for the Elysee Palace on May 7th is no longer a systemic risk. This was the reason the Chicago Volatility Index (VIX) plunged by an incredible 24% once Fillon and Comrade Jean-Luc conceded. This was the reason Société Générale, my preferred French bank to bet on a Macron win, surged an incredible 10% in one session on the Paris bourse. Like Sherlock Holmes’ dog that did not bark, the market’s euphoria was based on what did not but could so easily have happened.
Two: as the French OAT-German Bund political risk premium compressed dramatically, banks in Italy and Spain became a mathematical license to print money, as I had predicted in successive columns since March. France’s fragile banking system can no longer trigger capital flight from Europe and contagion risk.
Three: Fillon’s Gaullists (Les Républicains?) were humbled and Benoît Hamon’s Parti Socialiste (the party of Mitterrand and Léon Blum polled a pathetic 6%!), the twin political pillars of the Fifth Republic founded by the legendary General de Gaulle in 1958, both collapsed in this election. Something profound has happened in French politics if a 39 year old Enarque with no political party (Louis XIV was 39 too, though too dumb to be accepted at ENA!) and zero deputies in the National Assembly could be the next President of France.
Four: Mark Twain was right. History does not repeat but it surely rhymes. In 2003, Marine Le Pen’s odious Papa reached the second round before the French establishment held its nose and rallied around President Chirac. Fillon and Hanon have now thrown in their support for Macron, the next anointed republican monarch. This is the best possible scenario for the EU, the euro, the ECB and even the Swiss National Bank, who no longer has to brace for another 2012-style surge in the Swiss franc. A Greek debt deal is also now a slam dunk.
Five: President Macron on May 7th (it ain’t over till it’s over, Yoggi Berra warns us!) would greatly increase the prospect of Chancellor Merkel winning the German election in the autumn. After all, Berlin would no longer have to anchor a Eurozone on the brink of catastrophe, as could well happen if Le Pen wins the French presidency. Political risk will be less of a sword of Damocles on the financial markets once France is no longer the epicentre of systemic geopolitical risk in Europe, as it was in 1789, 1792, 1804, 1815, 1830, 1848, 1870, 1940, 1958, 1968, 1981, and yes, 2017! Vive la République (the fifth one since the Great Revolution, to be sure).
Macron’s acolytes in the Banque Rothschild may find it premature to reach for the monk Perignon and the widow Clicquot. The legislative elections in June makes it certain that Macron and En Marche will have to “cohabit” with a Prime Minister from the (hopefully) centre right. This could generate political and fiscal malaise in the heart of Europe – and, yes, resurrect the CAC-Quarante bears! Like Trump and Boris, Macron has scaled the political Mount Olympus via a movement, not a party.
The French election was a steroid shot for the value of euro dollar, now just below 1.0935 as I write. The euro has now completed the classic Fibonacci retracement of its losses since Trump’s election win last November 8th. I would not be surprised to see the euro retest its May 2016 high of 1.1610 (seems so long ago in the Stone Age before President Abu Ivanka!). Yet this can only happen when Macron wins the second round on May 7th and imposes his policies on the National Assembly this summer. So the real metric of risk I track is the French OAT–German Bund 10 year government debt spread, narrowed by 20 basis points since April 24th. Dr Mario Draghi will not accede to German, Dutch and Finnish demands for higher policy rates while positioning on the long euro trade is a bit crowded. This means the euro’s path higher will not be linear!
Currencies – Sterling can rise to 1.36 after the UK election
“England has no permanent friends and no permanent enemies, only permanent interests”. This observation by Victorian statesman Lord Palmerston to justify cynical imperial diplomacy applies equally to Theresa May and the Conservative party. The Prime Minister stunned the financial markets with her decision to call a general election in June, even though Downing Street had denied rumours she would do so. Mrs May knows that a snap election will enable her to increase the Conservative party’s majority in the House of Commons to at least 100 MPs. This electoral calculus has seismic implications for the sterling dollar exchange rate, cable. My call? Sterling rises to 1.36 after election day in June. Why?
One: London bookies put a 28% probability that the Tory majority in Westminster will rise to 100. Fine. This means Mrs May will finally win political legitimacy and votes – to secure a soft Brexit deal with the EU. The malign influence of the 50 odd “hard Brexit” Tory backbenchers on 11 Downing Street would be diluted. This means Britain will finally enjoy a stable Conservative government led by a Prime Minister who won a general election in her own right, not merely inherited it after David Cameron committed a political hara-kiri last June. This is sterling bullish.
Two: the EU divorce settlement will be more easily negotiated since it will no longer be held hostage by the virulent anti-Europe hard exit factions in the Conservative party who have engineered regicide in Tory politics so many times since Mrs Thatcher’s ouster in 1989. This scenario is sterling bullish.
Three: Britain can increase its fiscal spending after the election. Given elevated inflation risks after the 15% sterling fall after June 23rd, the Bank of England would accelerate its timetable for a rise in the money market policy rates. This is sterling bullish.
Four: Mrs May will insist on immigration reforms, border curbs and freedom from EU courts, as these are key Tory demands. Yet she could well compromise with the EU on trade and “passporting” rights for banks operating in the City of London. This means the risk of a breakdown in Brexit negotiations fall while the odds of a deal more favourable to the banking oligarchs of the Square Mile increases. This is sterling bullish.
Five: it made strategic sense to be bearish on sterling since at least the autumn of 2014. Now politics and monetary policy argues that it is insane to be bearish on the pound. The sterling bears will face the mother of all short squeezes as the structural short position in Planet Forex is assailed. This is sterling bullish.
Six: the Scottish National Party (SNP) swept every Scottish seat in parliament in the 2015 election. If the SNP loses Scottish seats to the Tories in June, the Prime Minister will gain the political capital to ignore Nicola Sturgeon’s call for a new referendum on an independent Scotland. This will be a reprieve for the fate of the United Kingdom and will defuse the uncertainty time bomb. This is sterling bullish.
Seven: the 2017 election will write the political obituary of the loony left leader of the Labour Party. Jeremy Corbyn is the Micheal Foot of our era, an unelectable asset for an incumbent Tory (lady!) Prime Minister. My advice to Mr Corbyn? You turn if you want to. This lady’s not for turning. Net-net, Labour could well lose 40 seats in June. UKIP? A sad joke. This is sterling bullish.
Eight: I am no expert on UK politics, but friends in London tell me the Tories will thrash Labour in the Midlands and the North of England while the Lib Dems pick up three to five seats in Southwest England and the Home Counties. Could Theresa May lead a government with 390 seats in the Commons? Yes, she can. This is sterling bullish.
Nine: Britain high propensity to import ensure that food and petrol prices will continue to rise in 2017. Yet sterling’s surge in April even ignored mediocre retail sales, a classic result of consumer inflation. The balance of power in the next MPC conclaves in the Old Lady of Threadneedle Street will tilt to tightening, not easing. This is sterling bullish.
Ten: I have abandoned the “short sterling” paradigm that motivated my post Brexit positioning. Even the Maestro of Palm Jumeirah is long the quid. My call? A 120 seat landslide majority for the Tories and 1.36 on cable in June. So there!
Macro Ideas – Time to buy the pullback in Russian equities
When Donald Trump won the US election last November, my immediate strategy idea was to buy Russian equities and US money center banks and sell the Mexican peso and long duration US Treasury bond leveraged ETFs. Russian equities went ballistic after Trump’s win as Moscow’s MICEX index rose 26% in the next three months. Friends in the City assured me that the new American president would repeal post Crimea sanctions in his quest to embrace Putin. Great powers do not care about faraway little countries about which we know nothing, an argument Neville Chamberlain used to justify the death rattle of Czechoslovakia at Munich. A generation later, Brezhnev’s decision to crush the Prague Spring with Red Army tanks did not prevent Nixon-Kissinger’s policy of détente. International relations are based on hard power and national interest not the bombast of a real estate salesman, even one elected to the White House.
In mid-January, the Russian stock market indices peaked and fell 12–14%, surrendering half their post-election gains. The links between Trump’s campaign and the Russian embassy, FSB cyber hacking the Democratic Party’s computers, the brutal endgame of the battle of Aleppo and Trump’s U-turn on an early end to sanctions soured investor sentiment on Russian equities. The selling frenzy in Moscow was amplified after the 8% plunge in crude oil since March.
The US Treasury has rejected Exxon Mobil’s sanction waiver request for a new Black Sea drilling deal with Rosneft, the state owned Kremlin colossus built on the carcass of Yukos. The foreign policy establishment in Washington, London and Berlin obviously does not want to lift sanctions on Russia until Putin makes concessions in Ukraine and Syria, which Putin will not do since financial market priorities do not dictate his geopolitical decisions. Even President Trump conceded that US-Russian relations are now near all-time lows. The American cruise missile strikes on a Syrian air base have derailed any prospect of an imminent Russian-American diplomatic rapprochement. The tragedy of great power politics once again leads the world to the brink of catastrophe.
However, May 2017 means markets will shift focus from the Kremlin’s relations with Washington to its relations with Saudi Arabia. There is no doubt in my mind that Russia cannot risk another oil price crash and will roll over the output cut pact originally brokered by Saudi Arabia last December.
The promotions of Prince Abdel Aziz bin Salman to Energy Minister and ex air-force pilot Prince Khalid bin Salman to be the kingdom’s ambassador in Washington suggest Saudi Arabia will do its best to prop up oil prices now that West Texas crude has fallen back to $49. The Saudi decision to reverse pay cuts and benefits for the kingdom’s public sector also necessitates higher oil prices. Saudi Arabia has also floated a $9 billion sukuk in the international capital markets to ease the credit crunch in the kingdom. Net net, the OPEC output cuts will be extended in late May. This makes Russian equities at 6.4 times earnings once again a value play.
Russia’s energy/commodities exposure and geopolitical risk premium will mean it will always be the valuation Cinderella of emerging markets. However, despite Syria, Ukraine, sanctions and cyber-espionage, there are macroeconomic reasons why I would nibble at the Russian equities index fund (RSX) now that it is down 8% from its highs. One, crude oil is at the lower end of a $50–60 range. Two, Secretary Tillerson’s trip to Moscow and the Trump White House decision to forewarn the US about the Tomahawk cruise missile strike in Syria suggests Washington does not want to demonize and isolate Russia. Three, Russia has emerged from recession and could even deliver 1% GDP growth in 2017. Four, despite the dramatic falls in inflation and interest rates, Russian government bonds still offer attractive risk adjusted yields. The central in Moscow just surprised financial markets with a 50 basis point rate cut. Five, Jim Rogers has just gotten bullish Russia – and bearish India on relative valuation and earnings growth criteria. The cofounder of the Quantum Fund has a point here. Six, the plunge in implied volatility means it is rock and roll time in risk asset – and Russia defines risk assets. So I revert back to Wall Street folklore, an idea that served my readers so well in Pakistan, Argentina and even Russia in 2016: “the big money is made when things move from Godawful to just plain awful”.
This article was originally published in the Khaleej Times on 30th April 2017.
