Europe at a crossroads
On March 29, the UK triggered Article 50 to begin the process of leaving the European Union. Does this represent a crisis point for the European project, as some commentators suggest?
Pro-EU election results would be welcomed by the markets and should offset some Brexit-related uncertainty
Or will Europe's "super cycle" of 2017 elections show that voters are resisting some of the more anti-EU forces? So far, at least, the pro-EU side seems to be winning:
Italy is the elephant in the room: CDS spreads, an early indicator of severe market distress, have doubled there since 2016
Such developments would be welcomed by the capital markets as positive steps for the EU, and they may help offset some of the uncertainty caused by Brexit. With Germany's economy doing well and the potential for stronger ties between Paris and Berlin, we could ultimately begin to see a stronger integration of the EU and euro area.
Italian voters to get their say
But Italy is the elephant in the room. It has an economy with weak growth rates, a weak banking sector, a governing party at risk of splitting up and a political mood that is increasingly turning anti-European. If the country doesn't hold a snap election this year, a regular election will be held in the spring of 2018. Given Italy's challenging economic straits, it is entirely possible – or at least not easily dismissible – that Italian voters will want to leave the euro and/or the EU. The markets seem to share this view: Spreads of credit default swaps, which can be an early indicator of severe market distress, have essentially doubled in Italy since early 2016.
In the US, UK and other Western nations, the populist trend that opposes globalization doesn't seem to be abating
All told, the investment implications of Europe's super cycle are mixed. The positive view is that European political uncertainty has marginally eased and should improve further if the election outcomes in France and Germany turn out to be benign; the euro and euro-area assets could benefit from this development over the course of 2017. The more challenging possibility is that political risks will continue to impact capital markets – and not only because of Italy. In the US, UK and other parts of the Western hemisphere, the populist trend that opposes globalization and supports stronger nation-states does not seem to be abating. There may be no early respite from the ongoing uncertainty and instability for the markets.