HILP Moi: Markets React to French Election Surprises

Markets are not very good at pricing for extreme events that come with a low chance of happening; high-impact, low-probability (HILP) events. Pricing the extreme left tail is virtually impossible; investors just tend to cross their fingers and hope it doesn’t happen — the war in Ukraine, for example, was never priced by markets. Nor was a pandemic. After both markets have generally mean reverted. Which is why it’s so interesting to watch markets try to price an extremely unlikely event – less a black swan than a charcoal one.  

The current one is Rassemblement National (RN) winning the European Parliament elections in France, causing chaos and the euro sliding. But is the recent move in French government bond yields really about the death of the euro? Or Frexit? I’m less certain about this – I think it may be more about the inherent fragility of French debt, fears about unfettered spending and rising deficit premia.  

What’s interesting is that Meloni has managed to keep Italy on the level. Even if Macron’s snap election gamble backfires on him (as well it might), it may not be that bad all round. Markets may well be overreacting. They tend to do so when pricing extremes; and they may overreact more in the coming weeks.

European Stocks Slightly Calmer After Macron Snap Election Call

European stocks gave up tentative early gains yesterday to trade down more than 1% by the afternoon, with the CAC 40 index in Paris down a further 1.3%. Shares in Europe are a bit calmer this morning and French yields are back down a touch, but markets appear increasingly nervous about the risks for a split in the Franco-German core. German inflation for May was confirmed at 2.4% but the market is moving on the political risk premia for the time being. And France is starting to behave more like peripheral debt, which is worrying, albeit it may prove fleeting. Le Pen doesn’t want to take France out of the EU.

French government bond yields ended a little off the highs but there is more stress to come as we head into a very uncertain election. French-German spreads kept widening yesterday as rumours circulated that Macron could resign and the centre-right Les Republicains leader called for an alliance with the RN. We had fresh multi-month highs in spreads, which reflected the risk premia market participants see from a hard-right win in the parliamentary elections. This pressed the euro down further as it hit a fresh almost 6-week low against the US dollar.  

Risky Business? FOMC Likely to Push Back on Cuts

It’s big day for the US risk events. The FOMC is likely to push back on interest cuts – instead of three this year and three next, expect the dot plot to show two this year and four the next.  

This won’t upset markets – slightly fewer than two is currently priced for this year. In fact, I think the barrier to cutting is coming down quite quickly. Powell has tended to sound quite dovish in the press conferences lately and with the gap lower for EURUSD on Monday from the EU election results there is the potential for the dollar to finish up a bit lower today.  

Look for the removal from the statement of the sentence: “In recent months, there has been a lack of further progress toward the Committee's 2 percent inflation objective.” That would signal they are close to a cut.  

US inflation data for May is also due out. This could help shape how Jay Powell talks in the press conference but wouldn’t have any impact on members’ forecasts. But if it’s slower than expected we could see Powell take a move dovish tilt. Consensus is for +0.3% month-on-month, which is not quite enough to green light a cut but we could get a slightly lower +0.2%. I think they are seeking to trim some level of restriction from monetary policy with the eco data pointing towards a slowdown and unemployment rising. That tends to suggest a cut in September and one more this year.  

The Big Apple

Apple hit an all-time high after its AI announcement. However, at Apple vs. Nvidia – seen a Bloomberg Intelligence report indicating that the Technology Select Sector SPDR fund (XLK) may be forced to sell more than $11bn in AAPL stock and purchase almost $10bn in NVDA shares to comply with index rebalancing requirements. It could take place on Jun 21st assuming NVDA has a larger market cap than AAPL by Jun 14th.

Healthy market? Record high for SPX and NDX on a 7% jump for Apple stock.

US Election Approaches

Finally, we haven’t talked too much about the US election lately with the UK and now France in the foreground, but it’s shaping up to be a cracker. Trump has been convicted. Biden’s son has been convicted. What else is in store? Biden being replaced at the last minute? Who knows.  

For markets there is increasing risk around this event in the near-term – deficits, trade, tax, etc. But also check this. Trump, who this week dubbed himself the “crypto president" says he wants all remaining Bitcoin "to be made in the US". Whatever that means.