Dramatic Response to French Election

The results of the first round of the French election spurred a dramatic
response in the capital markets.
  Our thesis
that there is no populist-nationalist wave sweeping the world
is supported by the previous results in
Austria, the Netherlands, and now France. The AfD in Germany is wilting in the polls, and there too the center will hold.  The populist-nationalist wave seems
a result of the Anglo-American two-party system in which the center-right party
adopted part of the populist-nationalist platform.  

The euro gapped higher in pre-Pacific trading.  It had finished the
week in North America a little below $1.0730 and jumped to almost $1.0860 on
its way to nearly $1.0940.
  However, it drifted lower in Asia and
steadied in Europe around $1.0850.  The gap is found between $1.0738 (Friday’s high) and $1.0821 (today’s
low).  The immediate issue is what kind of gap it is?  The longer it is unfilled,
the more bullish are the implications.  

There are some events that are the week
that could challenge it.
  The ECB meeting stands out as a risk. 
The March meeting was seen as hawkish, and this does not seem to be Draghi’s
intent.  Draghi’s comments before the weekend reiterated the line about
rates being this low or lower.   The ECB’s Nowotny explained
that policy for 2017 has already been set,
and a decision about 2018 will be made in
the second half.    

Meanwhile, as President Trump’s 100-day in office approaches, there seems
to be a push to make something happen,
but this could be a dangerous game if the inflated expectations are not
  In particular, there has been the suggestion that a vote
on health care reform could be held this
week, but it does not look ready.  Trump reportedly will make an
announcement on tax reform (Wednesday), but this is likely more of a wish list that detailed proposals. 
Reports suggest that it will not include
the controversial border adjustment tax.  

Also, some measure must be passed
before the end of the week on the spending authorization of the federal
. Some sort of short-term
extension rather than a real solution is likely.  It is what has happened
to the debt ceiling as well.  The Treasury Department has already begun
taking extraordinary measures, including reducing its cash balances at the NY
Fed, which some have linked to reducing the cost
of dollar funding in the cross currency swaps.  

Investors’ sight of relief at the results of the French election is the
main driver today
.  It is sufficient to overwhelm the decision by
Fitch before the weekend to downgrade Italy’s sovereign rating to BBB from
BBB+.  Italian 10-year bond yield is off six basis points, while the
German 10-year yield is up nearly 10
bp.  Spain’s 10-year yield is down five basis points.  France is off 10 bp. 

In recent weeks, the fund trackers have reported strong demand for
European stocks
.  European bourses are sharply higher today.  
The CAC leads the way with a 4.4% advance that has lifted the benchmark to its
best level since 2008.  The DAX’s nearly 3% gain lifts it to a new record
high. While sterling itself is marginally
firmer, the FTSE 250 is up nearly 1% to a new record high.   The Dow Jones
Stoxx 600 is up almost 2%, led by the financials, industrials, and telecom.  None of the major industry groups
is up by less than 1%.   

Asia-Pacific interest rates and equity markets rose.  The MSCI
Asia Pacific Index rose 0.4%, for a third consecutive advancing sessions.
  The Nikkei advanced more than 1% for the second consecutive session,
something not seen since January.    Chinese shares were not invited to the party.  The
Shanghai Composite lows 1.4% amid reports of a regulatory
crackdown.  It was the largest decline of the year.  It is off nearly
5% since the 15-month high was set two
weeks ago.  

As the euro gapped higher against the dollar, the dollar gapped higher
against the yen.
  It reached almost JPY110.65 before settling back
down around JPY110.  The gap is found
from the pre-weekend high (~JPY109.42) to today’s low
(~JPY109.82).    However, we continue to warn that the safe haven status of the yen is misunderstood.  The real safe haven is US Treasuries, and the yen moves inversely.  US Treasury yields
jumped in from below 2.25% in late pre-weekend North American dealings to
2.31%-2.32% in Asia.  It has largely held above, 2.30%, the old

The euro-yen cross, which has been a key axis, exploded higher. 
Before the weekend, it reached a high near JPY117.30.  It opened around
JPY119.55 and reached almost JPY121 before steadying, and like the euro has
pulled back toward its opening level.   The gap is found between JPY117.30 and

There have been three economic reports that have largely been lost in the shuffle.  In the UK,
Rightmove house price index rose 1.1% in April.  It is the second month of slower gains, but well above the six and 12-month averages.  Still, the
year-over-year pace continued to decelerate
At 2.2%, it is the slowest pace in four years. The CBI reported softer
business optimism and weaker orders while
selling prices remained elevated.   Sterling continues to trade at the upper end of the range set on May’s
unexpected election call last week. 

Germany’s IFO survey was better than expected.  The measure of
the business climate rose to112.9 from 112.4.  The market expected a flat
number.  It reflected an upbeat assessment of current conditions (121.1 vs. 119.5), while the
expectations component slipped a little (105.2 from 105.7).

The North American session features the April Chicago Fed’s National
Activity survey for March and the Dallas Fed manufacturing survey for April.
The highlight of the week is the first estimate of Q1 GDP, which, as we have
noted, has underperformed the other quarters on average since the end of the
financial crisis.  The pullback in consumption after a strong Q4 16 will
likely prove temporary.   Meanwhile,
the drag from the energy sector has been lifted
US oil output has risen by nearly 500k barrels a day over the past five-six months, and rig count and related activity have improved.   The Fed’s Kashkari,
the lone dissent against the March rate hike, speaks at two functions in
California today.


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