Ahead of the second round of France’s election, extremely low levels of equity-market volatility indicated investors were assigning a very high probability to victory by Emmanuel Macron. Markets were right. The opinion polls were right. A wave of populist, anti-globalisation politics across Europe, and from the United Kingdom to the United States, seems to be starting to recede.
Now the hard work begins. If Macron is going to have any chance of delivering his campaign promises, he needs to find a way to build a power base. France’s legislative elections are taking place in June, and Macron’s newly created “En Marche” is more of a movement than an organised political party. It may win few if any seats in the National Assembly, despite having candidates in every constituency.
More generally, Macron may not be able to secure a majority in parliament, if the traditional parties, like the centre-right Republicans, refuse to work with him. That said, given Macron’s centrist position, a coalition between several parties seems more likely for him than it would have been for his rival Marine Le Pen.
Thus, as president, Macron might face several constraints. The short-term consequences of this could well be gridlock. One of his priorities is his pledge to rewrite the French labour code. Given the likely opposition from the unions, which have previously demonstrated that they can bring France to a halt, this could prove difficult. If these constraints impose themselves in the early stages of his presidency, Macron could quickly lose the momentum he needs to succeed.
However, France needs to drive an economic reform agenda that has repeatedly stalled for more than 30 years. Will Macron be able to succeed where others have repeatedly failed? Macron’s electoral programme contains further European Union (EU) integration and he intends to put in place some protectionism at the European level (e.g. a “Buy European Act”). It also includes proposals for supply-side reforms, paired with demand-side inducements.
Impact on the Economy and Markets
Markets reacted with optimism after the first round of the election. Equity markets advanced strongly and traditional safe-haven assets such as German Bunds and gold declined. Today, the question remains: What may Macron’s victory mean for markets, as well as for the political landscape in France and more generally the European Union?
In terms of immediate investment opportunities, we think that the favourable outcome has already largely been priced in. But as European-election risk subsides, we believe global investors should shift their attention from the political risks of another euro crisis—or even a breakup of the entire EU— towards the striking improvement we have seen in eurozone economic data. Improving data from the economic and corporate front could provide Macron some momentum for the first couple of weeks of his presidency.
As the risk of monetary union breaking down diminishes, French government bond spreads, and those of peripheral markets to an even greater extent, will likely be capped. German Bund yields should move higher and French government bond spreads should narrow from their three-year highs.
Positioning For a Macron Presidency
Gross domestic product (GDP) growth has been robust in the first three month of the year, and fourth-quarter 2016 GDP growth was revised upward to 0.5% from 0.4%, despite a somewhat disappointing French GDP figure below that rate. Economists are forecasting real GDP growth to accelerate in 2017 in the eurozone, but more importantly, growth forecasts have been consistently revised to the upside since September 2016. We believe this could continue.
At the same time, inflation accelerated to 1.9% annual rate in April, getting closer to the European Central Bank’s (ECB’s) target—but without the risk of overshooting significantly. This will likely suppress enduring worries of deflation, possibly leading the ECB to retreat from its ultra-dovish rhetoric earlier than expected. An easing of political tensions following Macron’s victory should help this process.
However, while unemployment in the eurozone has fallen and the capacity utilisation rate has been rising, we are of the view that the remaining amount of slack still in the economy means it will take considerable time for a sustainable upward trend in core inflation—the ECB’s condition for any change in policy—and substantially higher yields in the eurozone. The central bank has barely changed its posture in the latest meeting, differentiating between a more upbeat growth assessment and a still subdued inflation outlook.
Any change in stance could trigger a rapid rise in German Bund yields and a narrowing of US Treasury-Bund yield spread, which would lead to a further rise in the euro against the US dollar. But for now, we expect only a transitory and limited positive impact on the euro. Macron’s victory doesn’t change that outlook.
The mixture of stronger economic activity, limited inflationary pressure and accommodative financial conditions should continue to support corporate earnings in the eurozone as the business cycle continues to strengthen. The business cycle in the United States is at a quite matured stage and the recovery in the eurozone is only a few quarters old. Combined with the different stance of monetary policy in the eurozone versus the United States, we think the backdrop is attractive for favouring European equities over US equities.
With elections in Germany coming shortly after the French elections, and the potential change of leadership in Berlin (the election is scheduled for September) we think the political risk premium will certainly remain somewhat elevated, but clearly, the French election result has erased a large part of it.
The comments, opinions and analyses presented herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.
Data from third-party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information, and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.
To get insights from Franklin Templeton delivered to your inbox, subscribe to the Beyond Bulls & Bears blog.
What Are the Risks?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Any further exits from the EU, or a belief that such exits will occur, may cause additional market disruption globally and introduce new legal and regulatory uncertainties.