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Perspectives

French election boosts markets

Jeffrey Sacks

By Jeffrey Sacks

Head - EMEA Investment Strategy

April 24, 2017Posted InForeign Exchange, Equities, Investment Strategy, Investments and Fixed Income

Macron’s First Place Finish in First Round Generates Eurozone Relief Rally

The first round results of the French presidential election were close with the top contenders as: Macron 23.5%, Le Pen 22.1%, Fillon, 19.6%, Melanchon 19.3% and Hamon 7%. Turnout for the French election was high at almost 80. For the first time in six decades, candidates from France’s two major parties will not be present in the second round.   

This result is a powerful positive boost for Eurozone markets, because the worst-case has been avoided of two extremists Le Pen and Melanchon, competing in the second round. In addition, while Le Pen’s National Front gained its most votes ever in a general election, she didn’t win with a high 20s percentage as seemed possible a few weeks ago.

European equities are up 3.7% so today, with the French index up 4.1% led by the bank sector up 8%. French rates have tightened by around 15 basis points, and the 10-year French OAT has moved back to a spread with 10-year German Bunds of around 45 basis points from more than 60 basis points Friday. The Euro reached a high in Asian trading of 1.0940 versus the USD and has eased to 1.086 (up 1.3% on the day), triggered by short-covering and stop-loss orders.

The two contenders  in the second round have radically different views. Macron aims to restore French influence in Europe, adapt France to a globalized world, cut corporation tax, strengthen the relationship with Germany, and create a taskforce to fight terrorism. Le Pen is anti-EU, anti-Eurozone, anti-immigration, ultra-protectionist, and wants to reduce the retirement age to 60. There remains residual uncertainty over the next fortnight, and also after the winner is announced.  These are three things to consider:

  1. French polls proved to be reasonably robust, which means that polls ahead of the second round vote on 7th May will be closely watched. The most recent poll showed Macron 62%, Le Pen 38%.   Expect the polls to narrow. While Macron has been immediately endorsed by Fillon, Hamon, and Juncker (President of the European Commission), Macron now needs to elaborate on his beliefs, and will be tested in the live debate with Le Pen on 3rd May. The two big variables could be how many of Melanchon’s blue-collar supporters turn to Le Pen; and which way the 6.2 million undecideds vote. It will also matter who manages to attract the vote of centre-left socialists – while Macron formerly worked for Hollande, their socialist programme has not been viewed as a success. Nonetheless, Le Pen’s sub-25% result despite highly committed voters from her base has left markets quite confident that the second round vote will go to Macron.
  2. Beyond the election, whoever wins is likely to face big challenges in building a majority in the Legislative Elections (11th and 18th of June). On the one hand the extreme views of a Le Pen win would be difficult to implement. On the other hand a win for independent outsider Macron could be compromised in implementing structural reform by the need to build coalitions to pass legislation.
  3. The ECB are likely to maintain their policy stance when they meet this Thursday 27th. A probable Macron win on 7th May is likely to keep them focused on the firming European economic data (see figure 2. below), and thus expect ongoing gradual exiting from their quantitative easing programme. Their unprecedented monetary easing over the past two years has helped to suppress volatility and contain political risk.

Conclusions

The French first round result lowers French and European political risk and this could be confirmed with an eventual Macron win. Nevertheless some European political risk would remain, with elections in the UK, Germany, and probably Italy to navigate in the next ten months, as well as the Brexit negotiations intensifying. So European assets might face less immediate downside risk and their relative attractiveness could increase slightly, however expect volatility to rise and selectivity to increasingly matter as equity and fixed income indices are not cheap in absolute terms. The discrete possibility of a Le Pen/Melanchon first round had concerned markets significantly.  Now that this won’t be the case, we would expect the bulk of a relief rally – re-rating Eurozone risk – to largely take place over the very short term.

The CPB Global Investment Committee meets this week. The current risk-level 3 weighing for French equities is 1.1% versus a strategic benchmark weighting of 1.3%, and overall Europe equities are weighted 7.9% versus the strategic benchmark of 8.5%. The European high yield weighting is overweight at 0.8%, versus 0.4% strategic, the European investment grade weighting is neutral at 2.1%, and European sovereign bonds are underweighted at 6.4% versus a strategic benchmark weight of 8.4%.

French election figure 1
French election figure 2