En Marche! : French Election Watch

Co-written with my colleague, Dean Turner, CIO Economist

• The polling booths have closed on the second round of the French presidential election. Exit polls show that this contest has been won by Emmanuel Macron, as widely expected.
• Investors will likely welcome this result, as it eliminates uncertainty regarding France's ongoing membership in the euro. However, since markets anticipated this result, they had largely positioned for this outcome, which may cap any gains in the short term.
• Our attention now turns to June's parliamentary elections, as these could determine how far the new president can go with implementing his economic program. Initial indications are that En Marche! may perform better than previously thought, which could bode well for Macron's presidency.

Our view

As widely expected, Emmanuel Macron has comfortably won the French presidential election. According to exit polls, Macron gained around 65% of the vote, Le Pen around 35% (see Fig. 1). This margin of victory was slightly larger that predicted by the opinion polls.

Investors will likely welcome this result, as it eliminates uncertainty about France's continued membership in the euro. Furthermore, the potential for meaningful structural reforms, and the likelihood of a more constructive dialogue with the EU, could see a rise in French business and consumer confidence in the months ahead. However, as this result was widely expected, markets had to a large extent positioned for it ahead of the final vote. So, any relief rally may be capped in the short term. The focus for investors will likely return to the fundamentals of the French economy, which looks encouraging and may improve further since another political hurdle in Europe has been cleared.

Our attention now turns to June's parliamentary elections; a positive outcome here for En Marche! will increase the likelihood of the new president delivering on his economic program. Opinion polls suggest that En Marche! will perform significantly better than previously thought.

Frexit risks gone; now it's about the economy

The key questions now for investors are what a Macron presidency will mean for the economy and for the outlook for the EU.

Macron has positioned himself as the candidate who can bring about real change to the political system in France, and with this deliver much needed reforms in the economy. As a minister in the previous government he was at the cutting-edge of institutional resistance to change that has hampered reform efforts in the past, and this seems to have given him the steely determination to break the cycle.

The focus of his immediate efforts are likely to be reforms to the labor market, taxation (including reducing the corporate taxation from 33% to 25%), and making the public sector more efficient. He aims to do all of this while in the short term keeping France's budget deficit within the 3% threshold advised by the Stability and Growth Pact (see Fig. 2). If Macron's reforms deliver the expected efficiencies and improvement to growth, his ambition is to reduce the deficit to 1% of GDP by the end of the parliament.

Whether or not the new president is successful in implementing his agenda, in the short term, economic momentum in France is still decent, in our view. Thus, unemployment should continue to fall, supporting domestic demand, and business investment could see a further improvement as economic and political uncertainty are reduced. Indeed, survey data already points to high optimism among the business community, which could mean there is some upside risk to our current growth forecast.

We expect France's economy to expand by 1.3% this year – the fastest rate since the euro crisis. However, by French standards, a 1.3% rate is still low, but we expect an improvement further out as reforms should complement the cyclical upswing currently in place. In 2018, we forecast growth of 1.4%, a rate above both that of the Eurozone and Germany (Fig. 3).

Finally, Europe. Macron has campaigned on an unashamedly pro-EU platform, emphasizing the importance of France once again regaining the economic credibility with its key ally, Germany. He has also professed his support for further integration in areas of fiscal policy and other measures to strengthen the foundations of the single currency. If Macron succeeds in strengthening the Franco-German axis, there is scope for progress here, although this is likely to be some way off.

Next stop: parliamentary elections

For Macron to successfully implement his economic program, he will need the support of the National Assembly, elections for which take place on 11 and 18 June. Polling data for these elections has been scarce, but a recent survey by Opinion Way (3 May) suggests that En Marche! could take a significant share of the 577 seats being contested. On their data, En Marche! could win between 249 and 286 seats, opening the real possibility of gaining an overall majority. If these estimates are broadly correct, it could be supportive for the economic outlook. Not only would it increase the likelihood of reforms being implemented, it may also reduce any lingering political uncertainty surrounding Macron's presidency.

However, it is still early days, and more polling data is needed before we can start to build a base case here.

For Macron to successfully implement his economic program, he will need the support of the National Assembly

ECB outlook

Economic data in the Eurozone has been solid so far this year. Real activity data is pointing to growth somewhat above potential. However, business surveys such as PMIs keep suggesting upside. On the inflation front, we expect inflation to go on hovering close to the ECB's target.

Accordingly, the balance of risks is shifting for the ECB. Macron's victory removes a major source of political uncertainty for the ECB; it should open the door for the ECB to reevaluate its current policy stance. We expect the ECB to adjust its forward guidance in June, as we don't see the UK elections on 8 June as a downside risk for the ECB. In September, the ECB should then announce its plans to wind down quantitative easing (QE) starting in January 2018. The announcement is expected on 7 September, in time before the German elections on 24 September (QE is unpopular in Germany). Unless there is a surprise win by an anti-European movement, we don't expect the Italian elections in early 2018 to hold the ECB back from winding down QE during 2018 (over 6–9 months), while interest rate hikes are expected in 2019 at the earliest.

Political risk subsiding, but still present

It is tempting to read Macron's win as another sign that the rise of populism is over. In our view, this is far from the truth. It must be remembered that although the margin of victory here was high, Le Pen still secured around 35% of the vote. This, together with the first round results, show that all is not well with French voters. Clearly populist sentiment is still strong, and not just in France.

To be sure, Geert Wilders did not perform as well as expected in the Netherlands, Le Pen missed by a decent margin in France, and Alternative für Deutschland seem to be losing support in Germany (although it still looks likely the party will enter parliament for the first time). And there still remains a question around how well the Five Star Movement will perform in Italy when elections are held there. However, even though populist parties are not taking control of governments in Europe, parliamentary representation has risen, and support for them is still sizable.

Unless economic conditions change or politicians start addressing voters' concerns, populism will likely stay part of the political landscape.

Clearly, populist movements' influence on the political landscape is being felt. Unless economic conditions change or politicians start addressing voters' concerns, populism will likely stay part of the political landscape. Just because it didn't succeed on this occasion, says little about the future.

Market implications

Bonds: Macron's victory was widely anticipated by the markets, so they positioned accordingly. From here, we believe there is limited further tightening potential for risk premiums on bonds of French public-sector and corporate issuers, as their extra risk premium has already diminished in recent days. The key driver for the markets is likely to be ECB policy with regards to its quantitative easing program.

Equities: The victory of Emmanuel Macron should be welcomed by Eurozone equity markets, but the impact is likely to be muted, given the strong gains after the results of the first round of the presidential elections two weeks ago.

The upside for French equities relative to the wider Eurozone is likely to be capped ahead of the parliamentary elections to be held on 11 and 18 June. Macron will need the support from the French parliament to implement his pro-growth economic program, but at this stage it is uncertain whether his party En Marche! can win a majority of seats.

Eurozone equities should, however, continue to find support from solid economic growth, exceedingly low interest rates and strong earnings momentum. The 1Q reporting season, which is in full swing, is likely to turn out to be the best quarter in a decade.

We have a cyclical tilt in our Eurozone sector allocation, with an overweight stance in energy, financials and materials.

FX: For the euro, we expect EURUSD and EURCHF to eventually break higher toward 1.12. A Macron presidency should be supportive for the euro and help EURUSD and EURCHF to stay on their appreciation trends, which should lead to 1.20 in EURUSD and 1.16 in EURCHF over the next 12 months. In the next one to two months, however, we think the upside on EURUSD is limited to 1.12, and a consolidation is likely after a strong rally and a lot of good news now being in the price.

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