DEUTSCHE BANK: Stop looking at France and concentrate on another huge risk to the EU -- Italy

LONDON — Markets can start to look past the risk of “Frexit” and focus on other issues facing the European continent now that centrist Emmanuel Macron has made it into the second round of voting in the French election, according to a note circulated to clients by Deutsche Bank on Monday morning.

Macron comfortably topped polls in the first round of the country’s presidential vote on Sunday, beating far-right, anti-EU candidate Marine Le Pen by roughly 2% of the popular vote. Macron gained close 23.8% of votes, while Le Pen picked up 21.5%.

Those results were pretty close to what had been forecast by pollsters, with polls for the second round pointing to a roughly 60-40 win for Macron. That, Deutsche’s Marc de-Muizon and Mark Wall argue, means investors can look past the immediate risk of a “Frexit.”

“Overall, given how close the first-round vote looks to the pre-election opinion polls and how Le Pen has consistently lost to Macron on second-round polls throughout the campaign, the market ought to feel relatively comfortable with the residual risk into the second round on 7 May,” the pair wrote.

“The market can afford to start looking beyond France.”

Political risk has not completely left the continent, Deutsche’s analysts make very clear, noting that a possible election in Italy later in the year, could bring concerns about the breakup of the eurozone back to the forefront of investors’ minds.

Italy has seen the Five Star Movement gain a significant amount of traction in the past couple of years, and December’s rejection of a referendum on constitutional reforms was widely seen as something of a populist uprising, meaning an election in the country could be the next big event to threaten the stability of the EU.

Here are de-Muizon and Wall once again (emphasis ours):

“Europe is still facing a busy political calendar with elections in the UK in June, Germany in September and Italy before next April (best guess: February, although something before year-end cannot be ruled out). In our opinion, the one with the highest risk of a market-negative populist shock is Italy, but with the Italian election at the back end of the sequence and potentially more than six months away, the market might not rotate to focus on this just yet.”

With Italian political risk still in the distance, European investors will now turn to the ECB starting to gradually unwind its quantitative easing programme, with the process likely beginning at some point in 2017.

“We think the next theme is set to be euro area reflation and the initial steps in ECB exit,” de-Muizon and Wall say.

“The macro data say that exit is coming in H2,” the pair add.

“The flash PMI held up very well in April. The real data growth signal is at a discount to the surveys, but the level of growth implied by the real data is nevertheless sufficient to keep the reflation theme going. If the real data converge up to the surveys, it is all upside for reflation.”

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