Citigroup said the French parliamentary election has unnerved investors as the country’s risk premium rises, but the market has yet to digest two possible scenarios and could affect stock markets across Europe.
“Our model suggests the market is pricing in somewhere between a benign outcome and gridlock…not quite, but still a few percentage points away from fully pricing gridlock,” Beata Manthey, the bank’s global head of equity strategy, told CNBC on Friday. “Squawk Box Europe”.
“However, the market does not factor in a far-right or far-left majority,” Mansi said.
The tax and spending plans of the far-right National Rally (RN) and left-wing New Popular Front (NFP) alliance are a major source of concern about future bond market volatility. Some economists warn that a debt crisis could ensue if either party gains a majority and quickly pushes through most of its proposals.
Both parties outperformed a centrist coalition including President Emmanuel Macron’s Ennahda party in the first round of voting on Sunday. However, the path from there looks very uncertain.
From a market perspective, benign outcomes could include the centrists finding some sort of path to victory, or a hung parliament in which neither party can advance its agenda.
Citi provides a scenario analysis of the different outcomes and what they mean for Paris CAC 40 Stock indexes – also based on potential changes in the spread between French and German bond yields, which hit a 12-year high on Friday.
“The results are still very unclear and we only have polls for the first round. So we will know more on Sunday night,” Mansi said.
“Let’s put the election announcement in the context of investor positioning. Europe has been a very popular market that has been performing well and international investors have moved from the US to Europe and positions have been stretched or net long, with extended Many, especially European banks, everything has turned neutral now, but it’s not negative,” she said.
She said that European stock markets are trading at a discount of nearly 40% compared to U.S. stocks, which is a “huge” gap compared with the historical average of about 15% to 20%.
“But valuations need a trigger. Increased political risk is not the trigger, that’s what worries me… Our model suggests that current pricing is in line with analysts’ expectations for fundamentals,” she continued.
“Put it this way, we downgraded Europe and upgraded the U.S. against a backdrop of increased political risk. Among developed markets, European equities tend to be the most vulnerable to these changes,” she added.
If the French election turns out to be “very market-unfriendly… the correlation in European markets is very strong. So if CAC sells off sharply, there will be spillover effects elsewhere,” Manthey said.
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