European markets celebrated the strong electoral showing by Prime Minister Mark Rutte’s party (VVD), which looks to ensure another term for him leading a center-right coalition in the Netherlands. The far-right party (PVV) led by Geert Wilders finished second, after leading in the polls through much of the campaign. Other parties performed well, supported by a strong turnout, ensuring a pro-euro coalition can be formed. The vote had become an early proxy for the broader nationalistic winds sweeping Europe. Test passed, the euro rallied more than 1 percent to a five week high of 1.07 against the dollar, and stocks rose across Europe on the news.
Still, markets are likely to remain on edge ahead of the declaration of Brexit later this month and French elections in May. While recent polls suggest that Marie Le Pen will fall short in her effort to win the French Presidency, even small changes in her standing or that of alternative parties in Germany (where elections are slated for the fall) are likely to be market-moving in the coming months. And, as I wrote yesterday, the risk of a return of the Greek crisis seems to be underestimated by markets. Against this backdrop, I am surprised that we are not seeing more pressure on the banking systems of France and the periphery of Europe that are seen as most at risk.
Beyond these dramatic and hard-to-quantify risks of an election result or a failure of a negotiation that leads to a country exiting the European Union or the euro, the broader challenge facing Europe is the how leaders, even those from mainstream parties, respond to these nationalistic and populist pressures now sweeping the continent. It is not surprising that, seven years after the start of the euro crisis, frustration among voters with a poorly performing European economy and continued austerity is on the rise. This could have a positive outcome, if it leads to countries that have the fiscal space increasing spending to support demand. But, conversely, I am concerned that the ability of political leaders to come together and make decisions on economic policy in the collective interest, whether about Greek debt, Italian banks, or exchange rate policy, will be tested in coming months. While I don’t expect any announcements, soon, such issues will surely be a focus for finance and central bank officials from the G20, meeting this weekend in Baden-Baden.