PRICE French Election POINT May 2017 MACRON’S VICTORY PROVIDES BOOST FOR EUROPEAN UNION Timely intelligence and analysis for our clients.
KEY POINTS . Emmanuel Macron’s victory—and Marine Le Pen’s defeat—in the second round of the French presidential election will be greeted with widespread relief in markets, with bond spreads tightening alongside rallies in stocks and currencies. Although Macron’s En Marche! movement is unlikely to gain a majority of seats in the National Assembly elections in June, his centrist politics should mean he can form a coalition government with the Republican Party.
. Macron is a strong supporter of the European Union (EU) and is likely to work well with German Chancellor Angela Merkel, which may make Brexit negotiations tougher for the UK but could also spell relief for peripheral countries seeking greater fiscal flexibility.
. The French financials and telecommunications sectors are among those set to benefit from a Macron presidency. In fixed income, peripheral sovereign bonds may come under pressure as the markets focus on other risks, including elections in other countries and the European Central Bank’s next move.
Emmanuel Macron becomes the 25th President of France, having defeated Marine Le Pen in a second-round runoff. The news that the far-right Le Pen has failed in her bid for the presidency will be greeted with widespread relief in markets, with bond spreads likely to tighten alongside rallies in stocks and currencies. As head of the newly formed En Marche! movement, Macron is unlikely to command a majority in the French National Assembly following the legislative elections in June, but his centrist policies should enable him to get parliamentary backing from both the center-right and center- left. His staunchly pro-European stance can be expected to strengthen the EU, which may make negotiations even more difficult for the departing UK but is potentially good news for struggling members such as Italy and Greece.
RELIEF RALLY TO PROVIDE STABILITY OVER THE SUMMER The result will be greeted positively by markets across the globe, partly due to sheer relief that Le Pen has not won. Although a Macron victory had been priced in to some degree after his first-round win, there was still enough concern over the possibility of Le Pen becoming president to keep prices in check. Now that Macron’s victory has been confirmed, a further rally can be expected. “There is no question that a Macron presidency is better for European equity markets than a Le Pen one would have been—this result lowers geopolitical risk in the region and should unlock economic opportunities,” says Dean Tenerelli, portfolio manager of the European Equity Strategy. “It should also be good for the euro. The biggest headwind for the currency this year has been the prospect of a far-right, anti-EU candidate capturing the presidency—with that removed, the markets will focus more on the fundamentals.”
Bond spreads are also likely to tighten as investor concerns over French sovereign risk have abated. “French 10- year bonds were trading up to 50 basis points over German 10-year bonds recently, but we expect spreads to tighten moderately from those levels closer to last year’s average levels,” says Ken Orchard, portfolio manager in global fixed income. “After that, with France ‘out of the picture’ as a political risk, the markets will begin to focus on other issues.”
NEW TERRITORY IN FRENCH POLITICS There is no precedent for an independent candidate becoming President of France, so Macron’s election has taken the country into uncharted territory. His first task will be to ensure his En Marche! movement wins as many seats as possible in the legislative election, being held on June 11 and 18. However, given the existing division on the left side of the French political spectrum, it is unlikely that En Marche! will gain a majority in the Senate (see shaded box), which will mean that Macron will have to find backing from other parties to approve a government— however, as he is essentially a status quo politician with relatively moderate policies, we expect this should not be a major problem.
THE FRENCH LEGISLATIVE ELECTION PROCESS French parliamentary elections are also based on the two-round system used in the presidential election— any candidate who receives more than 50% of votes in the first round is automatically elected, but if no candidate achieves this, then every candidate who receives more than 12.5% of votes enters the second round. As a brand new party, En Marche! will be up against highly experienced campaigners from the dominant Republican and Socialist Parties, which have frequently cooperated with each other in the past to prevent the far-right National Front Party from winning seats.
In our view, the most probable outcome is that the Republican Party, which is likely to be the biggest in Parliament, will back the newly elected government in the National Assembly. If this occurs, we expect to see a clear but modest shift from President François Hollande’s center-left policies to more of a center-right agenda, probably including a reduction in corporation tax and some loosening of labor laws to give companies the flexibility to renegotiate the 35-hour working week.
STRONGER EU: BAD FOR BRITAIN, GOOD FOR ITALY As a committed supporter of the EU, Macron is expected to work well with Merkel (and also with the Social Democrats' Martin Schulz should his party win the German election in the autumn), strengthening the Franco- German alliance on which the bloc depends. On Brexit, Macron has emphasized the importance of “defending the integrity” of the EU’s key principles on labor movement and trade, and he expressed concern that if the UK is seen to benefit from leaving, others may be encouraged to follow, which would “kill the European project.” Result: The UK will be facing an even tougher negotiating partner in Brexit talks than previously thought.
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However, Macron’s publicly expressed “sympathy” for the economic plight of countries such as Italy and Greece will raise hopes in those countries that he may help to soften what they regard as German-imposed austerity. A softer stance from the EU on austerity may even dampen support for some populist parties, which have gained ground on the back of the perceived unfairness of current agreements. “As things stand, the anti-EU Five Star Movement is on course to become the biggest party in Italy’s next election, which will take place either later this year or early next year,” Orchard says. He adds, “Macron’s victory may provide some much-needed support for pro-European parties in Italy—however, it is difficult to say what impact this will have on voter behavior.”
“Macron’s relationship with Germany is apparently very good, but so far his economic line has been very neutral,” says Tenerelli. “He has positioned himself as a centrist, anti-establishment candidate, but he has not yet shown himself to be particularly reformist. Hopefully, with the support of Germany, he will be able to get some things done—however, this remains to be seen.”
BANKING AND TELECOMMUNICATIONS SECTORS BRACED FOR “MACRON BOOST” Macron’s victory is potentially very significant for the French banking sector, as implied by the strong rally in banking stocks following the first round. “Macron favors gradual deregulation measures, which is clearly welcomed by the French banking sector,” says Tenerelli. “His victory should also continue to see a narrowing of French sovereign spreads, which automatically translates into lower cost of equity and funding for the sector. This is particularly important given that French banks tend to rely more heavily on market funding than other European banks.”
The telecommunications sector also looks set to be affected by Macron’s victory. For some time, there has been support within the industry for greater consolidation within French telecommunications, but efforts toward this end have so far been hindered at the political level. Macron’s pro-business leaning means that he is likely to be more amenable to industry consolidation, which should be positive for the larger incumbent players.
WHAT’S NEXT FOR EUROPE? After the relief over Macron’s victory has subsided, investors in Europe will soon begin to focus on other potential risks. In addition to the looming Italian election, there is also the possibility of upheaval in Spain if Catalonia presses ahead with its proposed independence referendum. It is not clear how this situation will develop—the referendum is opposed by the Spanish government—but it has the potential to cause market jitters and spread widening if the referendum is held and the result is a “yes” vote. “We are currently neutral on peripheral Europe but are looking to adopt an overall underweight position at some point,” says Orchard. As things stand, we are slightly long Italy, Portugal, and Cyprus and very underweight Spain.”
More importantly, there will be renewed focus on the ECB’s next move toward year-end. “Most analysts on the sell side expect a tapering from €60 billion per month to zero by mid-next year,” Orchard adds. “However, we believe the reduction in the ECB purchases will be much more gradual, with a possibility of the quantitative easing program lasting into 2019. In that case, we may see peripheral spreads staying low for longer, providing an opportunity to reenter a long periphery position if political risks do not materialize.”
“In European equities, we are slightly overweight France relative to the benchmark, with a broad spread of exposure—from domestic stocks with strong franchises, in areas like telecommunications and banking, to international businesses in sectors like engineering and consumer discretionary,” adds Tenerelli. “While we are not dramatically tilted either way, we are currently finding more opportunities in defensively oriented companies in sectors like telecommunications. We do not favor those areas that are dependent on strong growth, such as materials and energy, where we feel valuations are slightly ahead of themselves.”
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