Risk appetite down on Dutch fears and French promises

The markets’ fear of François Hollande becoming next president of France has been joined by increased political risk from the Netherlands, where the ruling coalition collapsed over failed negotiations on austerity measures designed to bring the budget deficit down to 3% of GDP next year.

Together, the two events have increased concerns about the fiscal outlook in the euro zone and made Europe’s rescue fund more vulnerable. The Netherlands, previously regarded as safe triple-A nation, must now be factored into risk calculations.

Already this week, risk aversion has gripped the markets. Dampening risk appetite was the announcement that the euro-region’s debt jumped to 87.2% of GDP last year, the highest ever level in the history of the single currency. Spanish, French and Dutch yields all rose. If Holland’s credit rating is changed or put on negative watch then this trend can only accelerate.

In France, Hollande repeated his intention to renegotiate the fiscal compact and shift its policies towards growth at the expense of fiscal austerity, adding to fears about the prospects for the euro if Hollande wins the second round of elections.

The potential for the euro zone countries to soften their commitment to fiscal targets and austerity policies could push sovereign debt yields higher, but it remains to be seen whether Hollande, if elected, would implement his policies once in power.

Should Hollande win and then implement his electoral promises, headwinds for the single currency could intensify because more funding difficulties for the euro zone core could undermine the efforts to create a credible firewall for Spain and Italy.

However, it should be remembered that Spain’s new prime minister Mariano Rajoy also declared he would unilaterally soften EU fiscal rules for the benefit of the hard-pressed economy, before backing down. The reality of power has turned many political promises to dust.

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