How to trade the populist threat in Europe ahead of the Dutch and French elections

President of French far-right Front National (FN) party Marine Le Pen delivers a speech during a political rally on September 3, 2016 in Brachay, France.
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The heavy political calendar in Europe and the significant rise in support for populist parties are making investors nervous.

But looking at the first two votes, in the Netherlands and France, Rabobank suggested go long on Dutch bonds versus French bonds.

"In underlining the threat populism poses as regards euro zone integrity, strong support for the PVV (a Dutch far-right party) come Mar 15 (the Dutch general election) stands to underpin core bonds including, paradoxically, DSLs (Dutch State Loans)," Rabobank said in a note on Friday.

Opinion polls suggest that the far-right Freedom Party (PVV) is set to gather the most parliamentary seats, but it will be far from reaching a majority. Meanwhile, the remaining parties are not interested in forming a coalition with PVV because the party withdrew from a ruling coalition in 2012 leading to the collapse of the government. As a result, analysts do not expect that even with a victory, the PVV will lead the next executive.

France, however, is slightly different.

"The logical trading upshot of this, then, is to go long DSLs vs. OATs (Obligations Assimilables du Trésor ) as even if one were to argue that we are taking too sanguine a view as to the impact of Dutch political developments on DSLs, the read across is likely to be more negative for OATs both as (Marine) Le Pen's fortunes are reassessed and as the outlook for the euro zone cohesion is challenged," the bank added.

Even without a populist government in the Netherlands, the expected increase in support for the far-right is likely to increase the chances of Le Pen, the leader of the French far-right party, in the presidential election, the bank said.

Le Pen, who has previously mentioned that if elected she would put France's euro membership to a vote, was placed first in the latest opinion poll projections. Though the French system entails two voting rounds to choose the president, which decreases the chances of Le Pen becoming the next French leader, although recent scandals in French politics could boost her position.

As such, fears about a European disintegration are rising.

"Concern over the integrity of the currency union is unlikely to simply melt away even if the populists, such as the PVV, do not enter govt. This is owing to the fact that the popularity of these parties is itself enough to drag the establishment further to the right or, put another way, to see establishment parties increasingly taking on the same hue as their populist opponents to ward off the challenge that they pose," Rabobank said.

"As a consequence, there is a discernible risk that European political rhetoric will adopt a more illiberal tone in the coming months, which only serves to tilt the odds toward wider peripheral spreads," the bank added.

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