The EU dodged a silver bullet Sunday, delaying any break-up of the union until the next wave of ultra-nationalists parties promise to dismantle it. While France's new president, Emmanuel Macron, garnered 66 percent of the popular vote, his competition was less than formidable. Marine Le Pen, leader of the National Front party, has been called everything from a fascist to a Nazi. Normally, such a candidate should barely register as polls close, however, Le Pen was able to convince one in every three voters that she was France's future. France's economy is in such bad shape that a sizeable portion of the French have turned to xenophobia to cure the ills of the Republic. Did Macron deal a crippling blow to anti-immigrant sentiment in France or is this a signal of a growing movement in France and across Europe?
With the French elections over, financial markets can return to worrying about the not so immediate threats to the euro. Italy's banking sector is still very vulnerable as is Portugal's. The ECB has yet to bail either out completely leaving insurance against their potential defaults very pricey indeed. A five-year Credit Default Swap (CDS) of a Portuguese corporate bond will cost 2.08 percent of the investment. In comparison, insuring against Turkey's political and economic uncertainty will cost 2.04 percent. Normally, a country like Portugal with the implicit backing of the ECB should be much cheaper to insure. Italy is not far off with insurance against its potential default putting investors back 1.60 percent. A collapse of the Italian banking sector would make Grexit look like a day at the park and thus the euro's current woes continue.
Markets pricing Turkey's CDS near 2 percent make Turkey's current risk level its lowest in 27 months. Turkey, despite armed conflict raging on three borders, is seen as less risky than energy-rich Brazil and only marginally more risky than Italy and Russia. Having put it's presidential referendum behind it, Turkey has no new elections coming up for the next two-and-a-half years and that means less uncertainty for the country.
Turkey's financial markets, like other emerging markets, rely on both domestic continuity and the lack of uncertainty to attract investors as well as high real returns. For high real returns to be more attractive than "risk-free" assets, the "risk-free" bonds of the United States, Germany, and Japan need to yield relatively nothing. To that end, all emerging market investors had their eyes turned to the Federal Reserve last week and as I had predicted the Fed did not raise rates nor did it imply it would at the next meeting.
The most interesting data coming out of the Fed minutes and subsequent jobs data revealed several important issues. While job-growth appears to be steady, real wage growth is nearly non-existent. While the "unemployment" rate is at near historic lows, the participation rate, is at near 40-year highs, increasing again last month. The participation rate is a measure of the total number of people employed relative to the entire labor force. So while only 4.4 percent of people are "unemployed" only 62.9 percent of the population that could work is actually working. This number actually decreased one-tenth of 1 percent from the previous month. In other words, fewer people are working.
While the headline unemployment number is great, the lack of substantial wage growth reflects a different story. Employees are reluctant to ask for higher wages, lest they be replaced. With inflation also below the Fed's stated 2 percent target, how would it even be possible for the Federal Reserve to raise rates at their next meeting? Practically no real wage growth in sight and an inflation rate below target spell expansionary monetary policy. Tightening would be potentially disastrous for the U.S. economy leaving the Federal Reserve with no real choice but to punt here. Any hike of the Federal Funds rate target would be disastrous for the U.S. economy.
With no Fed hikes imminent, dollar denominated debt will also yield less, which means investors will be looking overseas to park their funds. This will be great for emerging markets that can attract such capital. Countries like Turkey will continue to attract investments it appears as the benchmark BIST-100 index and debt markets continues to rally heading into the summer season.
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