UBS: Will Europe’s elections derail markets this year?

The main worry for investors is that this year’s elections might further undermine the EU and the single currency. Geert Wilders, whose Party for Freedom is on track to win the most seats in March’s Dutch election, has called for a vote on withdrawing from the EU. France’s Marine Le Pen, the National Front leader, implied that France will leave the euro if she is elected, and a referendum on EU membership could also occur. And Italians may be visiting the ballot box at a time when the anti-euro Five Star Movement rivals the incumbent socialist party in the polls.

On the bright side, the risk of anti-EU populists getting their way is low in most cases. Polls still show that Le Pen, though in the lead for the first round of the presidential elections, would be soundly defeated by either of her two main rivals in a second round. And even if she were to claim the French presidency, an outcome to which CIO assigns a roughly 40% probability, she would still need to secure parliamentary agreement for a Frexit vote, and to win it. Polls suggest that close to 70% of French voters oppose a return to the franc, one of Le Pen’s campaign pledges. Similarly, if Wilders emerges on top in the Netherlands, his party would struggle to find coalition partners or convince the Dutch public to back an exit from the EU. Among this group of nations only Italy exhibits relatively fragile support for the euro.

Of course, populists don’t need to take the reins of government to impair the outlook for growth or markets. If anti-EU parties gain ground in national parliaments, they could hinder economic reforms and European integration, while blocking further help to struggling Eurozone peers such as Greece.

In the meantime, uncertainty could put upward pressure on the bond yields of vulnerable countries. (Worries over the political outlook in France have already caused the 10-year government bond spread over German bunds to widen to a three-year high of around 75 basis points.) This trend, if continued, could contribute to a slowdown of economic growth, which has recently been holding up well.

Yet the worst-case scenario of a euro or EU exit by France,the Netherlands, or Italy still looks unlikely. In addition,the German election may lift markets. Chancellor AngelaMerkel and her Christian Democratic Union look likely tohold onto power. Even a win for her main rival, Social Democratic candidate Martin Schulz, might prove market friendly as it could shift policy toward higher government spending and greater tolerance of deficit spending by governments in Europe’s periphery. This outcome could provide additional support for the Eurozone economy as a whole.

Finally, as was the case last year, solid economic growth and improving earnings should enable risk assets to cope with heightened uncertainty. Global real growth should speed up to 3.6% this year from 3% last year – higher nominal growth is already expanding profits in major regions.

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