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The outcome of the EU elections has triggered a rise in risk aversion in Europe in equity, bond, and also FX markets, with President Macron calling snap parliamentary elections for early July. The markets are basically pricing in the higher probability that the far right climbs to power in France (presidential elections are not due before 2027), and such parties have in the past advocated for a “Frexit”, which would reopen Pandora’s box regarding the common currency.

The far right in France has toned down the anti-euro rhetoric in recent years, but a potential populist government increases the risk of fragmentation, which would be adverse for European banks. French banking stocks have also come under pressure as they could be an easy target from populists to fund excess deficits. Populists might also endanger one positive catalyst of the sector, which is cross-border consolidation. At this stage, we are neutral on European banks as the ECB has just started a rate-cut cycle.

Nevertheless, it is worth recalling a few salient points:

  • First, EU elections are peculiar because citizens tend to express their frustration in this ballot (over issues such as the cost of living, immigration, insecurity, and generally with “the establishment”). Hence, the results must be taken with a pinch of salt and might not be representative of the actual wishes of the citizens. In this respect, Macron’s snap election has some logic: let’s give the citizens a say over national politics. And if the far right gets a majority in parliament, then citizens will have the opportunity to evaluate its state of preparedness in office (Macron’s bet is obviously that it would be disastrous). The timing set by Macron also squeezes the left and it might not allow them enough time to conclude a deal (to be confirmed in the coming days). However, there is the risk of a fragmented parliament and ultimately early presidential elections in the event no government emerges.
  • Second, the centre right (European People’s Party) gained additional seats compared to the previous legislature, so the outcome of the election was more a redistribution of seats from the centre/centre left/greens to the far right than a tsunami for traditional parties.
  • Third, it is also worth keeping in mind that political factors, especially at the EU level, tend to have a short-term impact on markets. Volatility in some European market segments (French OAT, EURUSD, banks) could remain over the next few weeks, but we stop short of drawing any negative conclusions for the medium term. The key risk to watch is whether sovereign concerns resurface, like over 2010-12, but that would be a very negative reading in our view.

From a global perspective, EU elections are nonetheless a relatively minor market event. The US CPI on Wednesday and the FOMC meeting on the very same day will probably have stronger market implications – particularly as the latest job market report in the US has raised more question marks than anything else. How to reconcile strong job creation but rising unemployment in May? Which one of the two might the Fed prioritise? Is the labour market actually cooling? We think that a broader set of indicators is signalling a softening of the US economy, which, along with a 15% drop in oil prices over the past two months, should eventually prove supportive to taming inflation. Tomorrow, we expect Powell to renew his call for patience and to kick the can down the road to September for the first-rate cut.

In this context of rising political uncertainty but also a US cyclical slowdown that is no longer discounted, we reiterate our preference for defensive sectors within European equities. These sectors are mostly found in the low-beta markets that are the UK and Switzerland, which are our two top picks in Europe. Until this French election is clarified, their location outside of the eurozone is an attraction. Note that we recently upgraded two defensive sectors from N to OW:

  • Pharmas & Biotech: outside of Novo, the sector is not richly valued despite secular growth drivers and strong balance sheets. The US election still represents a risk, but so far the theme of drug affordability has been eclipsed by more pressing issues, such as immigration.
  • Household & Personal Care: Significant revenue exposure to Emerging Markets where the rise of the middle class is a strong reservoir of growth, and which saw a reassuring Q1 reporting season and attractive valuation levels.

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