PM May resignation and European elections outcome could precipitate several local snap elections while trade war tensions still looming

European elections see relatively high turnout and fragmentation. Turnout surprised on the upside, at its highest in 20 years (50.5% versus 43% in 2014), suggesting that most Europeans are still interested in politics and Europe. The two historical formations – Social democrats (SD) and European Popular Party (EPP) – have lost their majority. SD obtained 150 seats (-41 vs 2014) while the EPP got 177 seats (-42) with weaker results in Spain, Italy and Germany. These lost seats largely benefited the populist and nationalist parties, but also to the Liberals (ALDE) and the Greens which made a historical breakthrough with respectively 108 and 77 seats. Far-right “Europe of Nations and Freedom” led by the Rassemblement National in France and Lega in Italy could gather approximately 172 seats (+17 vs 2014) and, given the Parliament’s fragmentation, becomes the second political force. As we outlined in a recent paper (“European Parliament elections: More noise but some signals”), these European elections also have implications for domestic politics in several member states, especially in Germany and Italy where the results point to a sharp weakening of a government coalition partner, SPD and Five Star respectively, increasing the probability of snap elections in both countries.

In the US the past week saw financial markets become ever more pessimistic over the outlook for trade tensions with China, with the US adding Huawei to its ‘entity’ list. This restricted the tech giant’s access to US supply chains (and software). The US then added a 3-month reprieve, but also indicated a further five tech firms could be added. As markets began to fear inevitable trade pressure escalation, President Trump went on to suggest that maybe Huawei “would be included in some kind of a trade deal” – suggesting the possibility of a ZTE-like turnaround in US treatment. Uncertainty will continue until a meeting with President Trump and Xi takes place in June – if it does. Until then, expectations of a growth-sapping trade war have increased market expectations for easier Fed monetary policy, despite last week’s FOMC minutes suggesting no such expectation at its last meeting. In this regard, the most important US release this week will be April’s Personal Consumption Expenditure (PCE) inflation release. After a couple of soft months that the Fed described as reflecting ‘idiosyncratic’ and likely ‘transitory’ factors, markets forecast a stable month with ‘core’ prices remaining at 1.6%. Any signs that tariff increases are starting to push inflation higher could limit the Fed’s room for manoeuvre, although that is not likely this month.

In the UK, Brexit finally claimed Prime Minister May, who on Friday announced her resignation from Friday 7 June and the subsequent start of a leadership contest. Speculation of PM May’s resignation had been rife for months and we had forecast her standing down around the time of the EU elections and latterly in the week of the 3rd June when she had hoped to try to pass the Withdrawal Bill again (but now will not). A new Tory leader is expected to be in place before the summer recess. However, this is not the end. It is not even the beginning of the end. Be the next leader a Brexiter (Boris Johnson is favourite, but closely followed by Dominic Raab, Michal Gove and Andrea Leadsom), or a centrist (Jeremy Hunt, Sajid Javid, Matthew Hancock) they will still face a Brexit impasse that is difficult to challenge with the current Parliamentary arithmetic. This difficulty was re-emphasised by EU election results (as they currently stand), which saw the Tories return the worst result for a standing government in elections since the early 19th century – winning outright in a not a single region. In their place, the Brexit Party came out on top with 32% (from UKIP’s 28% in 2014, now 3%) of the vote. Yet while this appeared to endorse a “no deal” Brexit uber alles policy, it was Remain leaning parties that posted the biggest surprise with Liberal Democrats, Greens, Change UK and Scottish National Party totalling 39% (+22%). A new Tory leader will struggle to re-unite the Conservative Party and with the 31 October Brexit deadline looming swiftly after the party conference season, there will be significant risks of renewed tensions and a vote of no confidence. Our central forecast is for a further extension of Article 50 beyond the October deadline. We also see rising chances of a General Election.

Modi makes a successful return. Without a surprise, official results suggest Prime Minster Modi will return for a 2nd term. The 303 seats won by the BJP are not only way ahead of the majority mark (272 seats) but are also more than what it has achieved (282 seats) in the past. This victory by the BJP is not only impressive but also historic because it is the first time in almost 50 years that a single party secures an absolute majority for a 2nd successive term. Domestically, with the underlying growth momentum on the fall, reform agenda is therefore particularly important in any rise in potential growth. On top of the GST, digital payments and Bankruptcy codes, the government needs to enhance capital investment and create more jobs for the country. As BJP has promised, the government will focus on continuing growth expansion, banking sector clean-up, increased efforts to raise rural incomes and reduce income inequality. We expect Indian growth to remain relatively decent at 7.4% with accommodative monetary policy bias throughout the year. In addition, policy continuity is also seen as a positive for its currency and market over the medium term.

 

Upcoming events

US: Consumer Confidence (Tuesday), Q1 Preliminary US GDP Annualized, Q1 PCE Prices, April Pending Home Sales, Fed’s Clarida speech (Thursday), April Personal Income, May Chicago Purchasing Managers’ Index, May Consumer Sentiment Index (Friday)
Euro Area: ECB’s Coeuré speech (Monday), June German Gfk Consumer Confidence Survey, May French Consumer Confidence, May EMU Business Climate (Tuesday), May French Preliminary CPI Inflation, Q1 French GDP, German Buba President Weidmann speech, ECB’s Mersch speech, May German Unemployement Rate, May Italian Consumer Confidence (Wednesday), Ascension Day, May Spanish Preliminary CPI Inflation (Thursday), April German Retail Sales, Q1 Italian GDP, May Italian Preliminary CPI Inflation, May German CPI and HICP Inflation (Friday)
UK: Inflation Report Hearings (Tuesday), May GfK Consumer Confidence (Thursday), April Consumer Credit (Friday)
Japan: BoJ’s Governor Kuroda speech, March Cabinet Office indicators (Monday), April Unemployement Rate, May CPI Inflation, April Preliminary Industrial Production, April Retail Trade (Thursday), April Housing Starts (Friday)

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