May 24, 2017
This time round the pollsters didn’t get it wrong and Emmanuel Macron was indeed elected president of the French Republic on 7 May, as the markets had widely anticipated. Significant upswings had already taken place after Macron headed the first round results on 21 April, as well as following the no-holds-barred debate 3 May that left National Front candidate Marine Le Pen in disarray in the eyes of the French public.
As well as in France’s CAC40 index, the markets’ relief was evident in OAT spreads and the EUR/USD exchange rate. A fresh victory by the populists would have meant a serious possibility of a ‘Frexit’ referendum, and thus a renewed threat not only to the already fragile eurozone but the European Union as a whole. All these pessimistic thoughts seem to have dissipated.
As with ‘Trumponomics’, the markets seem to be weighing the likelihood or otherwise that the new president will ultimately be able to deliver on his ‘Macronomics’. A question mark will be the composition of Macron’s government, albeit a temporary one to hold the fort until the legislative elections to be held over two rounds on 11 and 18 June. For example, the designation as prime minister of Edouard Philippe, a long-time ally of centre-right presidential contender Alain Juppé, may influence the strength of Macron’s newly-renamed La République En Marche party during and after the elections.
Will the president attract more established right-wing or left-wing heavyweights? Or both, since he has positioned himself as embracing ideas from both sides of the political spectrum, rather than centrist predecessors in France that stressed their independence from either? If the decision of former Socialist premier Manuel Valls to rally to Macron is followed by further prominent political figures, the chances of Macron’s movement even obtaining an absolute majority will grow.
But even then, will he and his government be able to deliver real reforms? His two predecessors, Nicolas Sarkozy and François Hollande, never managed it despite their fairly comfortable parliamentary majorities. And investors are becoming impatient.
Philippe Brugère-Trélat, portfolio manager at Franklin Templeton Investments, says: “In our eyes, the chaotic French labour market in particular is ripe for reform. Unemployment is at unacceptably high levels, partly due to strict employment rules that make it difficult to shed staff. As a result, businesses are reluctant to take on new employees. To implement labour reforms, Macron is going to have to take on the unions and reduce their immense political power, which has been accumulated over decades of political infighting. Stiff resistance is to be expected, including some very noisy and visible national strikes. But we consider that a necessary step for the French economy. And if Macron is able to achieve success with labour reform, we could see operating margins in France rising, unemployment going lower and the overall prospects for GDP growth improving.”
” Macron is going to have to take on the unions and reduce their immense political power”
His colleague Dylan Ball of Templeton Global Equity Group adds: “The result could be positive for banking, insurance and potentially energy company stocks throughout Europe. On the other hand, Macron’s victory is likely to be less positive for companies we consider to be lower-growth. Additionally, the more defensive sectors of the equity market such as consumer staples could underperform, along with some telecommunication companies and utilities, where returns are heavily regulated.”
This view is not necessarily shared by all investors. Vincent Durel, European equity manager at Fidelity, sees potential for renewed consolidation in the telecoms sector if Macron, as he announced during his campaign, does indeed decide to reduce or sell completely the French state’s stake in Orange.
French company earnings in general could receive a 10% boost from Macron’s economic measures, which include fresh tax cuts and a plan to convert the current temporary reductions in social security charges into permanently lower rates. Plans to raise investment by €50 billion over five years would mainly benefit the energy, construction and IT sectors, he believes.
For bonds, Macron’s victory signals stability for now, according to Kenneth Orchard, global fixed-income portfolio manager at T. Rowe Price. He says: “French 10-year bonds were recently trading up 50 basis points over German 10-year bonds, but we expect spreads to tighten moderately, closer to last year’s average levels. After that, with France out of the picture as a political risk, the markets will focus on other issues, such as the Italian elections, where the anti-EU Five Star Movement is on course to become the biggest party, or possible upheaval in Spain if Catalunya presses ahead with its proposed independence referendum.”
However, Steven Andrew, macro fund manager at M&G Investments, begs to differ: “A disruption to the ‘euro fragmentation’ narrative should encourage investors to focus more on improving fundamental data across the region. Debt of peripheral sovereigns such as Portugal should benefit from a reduced fear of political instability.”
” They believe French yields could trend sideways or perhaps higher, based on eurozone growth”
David Zahn, head of European fixed income at Franklin Templeton, observes: “We expected French government bonds to experience a further relief rally, although the victory was largely priced in after the first round. Once investors see past politics, there could be underperformance by French government bonds. They currently trade on a similar level with German bunds, yet they are not similar. France has a large current account deficit, a significant budget deficit and high debt to GDP. In time, we think investors will realise that on fundamentals, French OATs should be trading much further out.”
Brandywine Global, a subsidiary of Legg Mason, believes that safe-haven yields, like German bunds, Japanese government bonds and US Treasuries, will start to rise. They believe French yields could trend sideways or perhaps higher, based on eurozone growth and inflation expectations; manufacturing in the region, as measured by PMI reports, was strong
ahead of the election. If all things remain equal, Macron’s presidency should also pave the way for the ECB to taper asset purchases later this year, and overall pursue tighter monetary policies. Once the European election season is over, market and economic dynamics should no longer be held captive by political forces.
For more information, please contact our Investment Fund Services (IFS) expert:
Ruben Deroover