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Do the Results of the First Round of the French Presidential Election Sound the All Clear for European Risk Assets?

Cambridge Associates

Stephen Saint-Leger

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Although the election results provide a powerful “risk-on” catalyst in the short term, the underlying long-term problems facing France and the Eurozone are unlikely to go away under a Macron presidency, so the old adage “sell in May and go away” may be vindicated yet again.

Pro-Europe, pro-reform, centrist but party-less young candidate Emmanuel Macron (24%) led National Front candidate Marine Le Pen (21.3%) in Sunday’s voting. With most of the supporters of Republican Francois Fillon (20%) and Socialist Benoit Hamon (6.4%) likely to back Macron in the second round, he will probably be elected president on May 7, barring an unforeseen electoral bombshell.

The rise in the polls of extreme left candidate Jean-Luc Melenchon in the closing weeks of the campaign opened up a significant risk of a final run-off between the two extreme wings of the French political system, with potentially catastrophic consequences for the Eurozone, the European Union, and the global trading system. As investors assessed the potential for this “nightmare” scenario, a lot of hedging of the euro and French assets took place. These bets are now being taken off as short-term investors and speculators do not want to be caught short or underweight in the run-up to the probable coronation of Macron in two weeks’ time. Momentum players will add fuel to the fire.

The French presidential election had big implications for monetary policy, not only because anything could have happened—so close were the four leading candidates to each other—but also because of the radically divergent potential political and economic outcomes. With German elections unlikely to upend the country’s pro-Europe stance and Italian elections not in focus until early 2018, European Central Bank (ECB) President Mario Draghi will now be able to turn his attention to the strengthening economy in the Eurozone, gently increasing inflation, and the need to appease the strict monetarists in Germany. That spells a higher euro (up over 2% since the French election) and a continuation of the recent trend in favor of European equities, buoyed by improving earnings and relative value. German bunds will buckle as the market brings forward its expectations, probably to the June 8 ECB meeting, for the first outline of a timetable for tapering quantitative easing.

Further down the line, all bets are off. As in the United States, the French president is not all-powerful, and the French return to the polls in early June to elect their parliamentary representatives. Both Republicans and Socialists, the dominant parties since Charles de Gaulle invented the current constitutional system of the Fifth Republic in 1958, failed to figure in the presidential run-off. Le Pen comes from a fringe party; Macron has no established party machine backing him, but depended on an improvised grassroots movement, his telegenic presence, and debating skills. This model does not carry over well to a diffuse parliamentary campaign with hundreds of constituencies up for grabs. Macron is unlikely to be able to field enough credible candidates, and so most likely the Assembly will end up as an unpredictable rainbow of factions left over from a crumbling political establishment, with a large bloc of anti-status-quo representatives. Bear in mind that for all the short-term relief that investors’ “nightmare” scenario did not play out this time, extreme parties made a strong showing, having polled over 40% combined (counting Le Pen, Melenchon, and other candidates with smaller vote totals).

The fact is, France and much of the Eurozone are still beset by deep structural problems. With the exception of Germany and its world-leading manufacturing and export sectors, big Eurozone countries such as France and Italy have stagnated for many years under the current system. Real incomes have flatlined and the younger generation is struggling to find good-quality, long-term jobs. Add to this the immense social strains caused by the influx of hundreds of thousands of migrants, and the picture remains somber. Sunday night’s result only provides a little breathing space and a short period of time gained in the hope that the new administration, probably working with a coalition of parties in parliament, will deliver a combination of reform domestically, with the ability to persuade Germany to relax the austerity mantra and re-distribute some of its gains to its Eurozone partners. Failing that, populist retribution in France could rise once more.

Stephen Saint-Leger is a Managing Director in Cambridge Associates’ London office.

Originally published on April 25, 2017

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