Money flows into European funds as German election helps quell populist fears

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The populist fear that spooked markets last year has mostly subsided, with Germany set to re-elect Angela Merkel as Chancellor and optimistic signs the European economy is enjoying sustainable economic growth. 

According to polls, Angela Merkel is largely expected to win a fourth term as German Chancellor, a factor markets have priced in since March and visible in the euro’s implied one week volatility, which has plunged 170 basis points in September. 

The market’s calm is a stark difference to the volatility that gripped equities and the euro just prior to the Dutch and French elections.

While populist party Alternative for Deutschland (AfD), with its anti-euro, anti immigration message, is expected to secure between 8 and 13 per cent of the vote, it seems investors are pleased with Merkel, and main opponent Martin Schulz’s pro-euro, pro-trade messages. 

Satisfactory stirrings of growth throughout the eurozone have prompted investors to begin snapping up European shares, with the DAX Index one of the top performing equity bourses this month. European equity funds have recorded inflows of more than $US30 billion so far this year.

“The cataclysmic events are now behind us,” says Jordan Cvetanovski, portfolio manager of the Pengana International Equities Fund.

“Even though it’s starting from a low base, the European economy is expanding faster per capita than the United Kingdom and the United States and there’s a broadbased upswing that will be hard to derail.”

European manufacturing and service sector activity accelerated in the month of September according to the PMIs and, should Merkel take the top spot, the euro is expected to strengthen further.

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“A victory for Merkel will mean a victory for the euro,” says Kathy Lien, managing director of BK Asset Management. 

Despite the positivity, the European Central Bank is not expected to raise interest rates for another two or three years, instead focusing on preparing the market for a smooth start to tapering its balance sheet expansion, which JP Morgan expects to be completed mid-2018.

“While rate adjustments will not come soon, sustained growth points to risks of an earlier shift in guidance,” says Bruce Kasman, head of economic and policy research at JP Morgan.

Monetary policy is back on the global agenda, following the US Federal Reserve’s decision last week to begin slowly winding back its enormous bond buying program, partially credited with jumpstarting growth in the United States after the global financial crcisis.

While the US central bank kept interest rates steady, it paved the way for another hike before the year is out and up to four possible hikes in 2018. 

Markets are largely accepting of tightening monetary policy in the likes of the US, Canada and possibly the Bank of England, which has seen a lift in inflation courtesy of a weaker pound stirling. 

The central bank hawkishness spilled over into the Australian market last week with the market changings its view that the Reserve Bank of Australia might raise interest rates as many as two times over the next twelve months. 

While persistently low inflation is still front of mind for central banks, Reserve Bank governor Philip Lowe was optimistic in Perth, saying the Australian economy is on the path to a new post-mining growth phase, despite the challenges of weak wages growth and record-and-still-rising debt.

Despite strength in the US dollar last week, the Aussie has remained stubbornly around the US80¢ mark, propped up by firm commodity prices and positive jobs data.