Macron’s reform agenda should be positive for economic growth in France.
As political risk falls, investors can now turn their focus to the corporate earnings recovery.
Emmanuel Macron is celebrating victory in the French presidential elections. Schroders investment experts Azad Zangana, Senior European Economist, Nicholette MacDonald-Brown, European Equities Fund Manager and Philippe Lespinard, Co-Head of Fixed Income discuss the economic and market implications of this result.
What does the result mean for the French economy?
“Emmanuel Macron is a pro-business, socially liberal politician. He has sought to create a movement to reach across the left/right political divide in France. We see him as following in the footsteps of reformers such as Gerhard Schröder in Germany or Tony Blair in the UK.
“There is certainly a lot to do in France in terms of structural reforms to improve the economy. Macron is seeking to implement measures to boost competitiveness, including a cut in corporation tax and liberalising the labour market. This latter is particularly important and could include making it cheaper for companies to hire and fire workers as well as looking again at the 35-hour week.
“There are questions though over how easy Macron will find it to implement these reforms. Elections for the French legislature are coming up in June and Macron’s new En Marche! party may find it difficult to gain sufficient seats. He may find himself in a “cohabitation” situation where he has to work with a Republican prime minister. This would be unusual, although not unheard of, and a coalition can certainly be forged if there are enough reform-minded politicians in the legislature.”
What are the implications for the rest of Europe?
“Macron is a devout Europhile and we see him as likely to galvanise efforts for European integration. He has in the past advocated budgetary supervision by the EU and could support a centralised budget to pay for national operations, and perhaps even risk-sharing. These are all excellent measures from a risk management perspective but perhaps are not wanted by every EU member. We view his victory as positive from a risk and macroeconomic perspective.”
What will be the stockmarket reaction to Macron’s win?
“We think this result will be taken positively by European equity markets and should allow the current rally in European stockmarkets to be maintained. His pro-euro and pro-business stance should allow equity investors to concentrate on the broadening economic recovery rather than being fearful of a potential breakup of the euro.
“Equity valuations remain very attractive in Europe, both in an absolute and relative sense, and earnings growth is improving. The recent first quarter earnings season has been the best in Europe for over seven years with many companies beating forecasts in terms of both sales and profits. We therefore think European equities could offer an attractive opportunity to investors.
“For France in particular, Macron's labour market reforms should aid the corporate sector.
“We also see scope for better flows into European equities now that the big fears over political risk have been resolved. Investors who had been on the sidelines may now return to the European equity market.”
How will the currency and bond markets react?
“In terms of the currency, we don’t see this election as changing the picture very substantially. The French and Italian economies have been the laggards in Europe and this may well continue in the short-term.
“For bond markets, there is likely to be a more significant impact. The Banque de France has been active in suppressing volatility in French bonds and the European Central Bank is now under less pressure to intervene.
“There has been a premium placed on German Bunds and US Treasuries because big institutional investors in Asia and the Middle East had stopped buying French bonds. They will now resume purchases again, taking their exposure back to neutral, and this will see the premium on Bunds and Treasuries fall away. This will help spreads, although we note there is a lot of issuance to come in France.
“Overall, we note that Macron’s strong commitment to Europe and to reforms should help strengthen the French economy and allow France to catch up with the European growth rate. In this scenario, we would expect French bonds to perform well.
What are the next political risks in Europe?
“The next big political event is the UK’s general election on 8 June. However, this is very unlikely to yield anything other than a stronger Conservative government.
“The German elections follow on 29 September but, again, we see these as low risk. Angela Merkel may lose but this would only be to her current junior coalition partners, which would not be a concern for investors.
“A bigger risk of Europe’s stability is Italy where elections are due by May next year. The anti-establishment Five Star Movement, led by the former comedian Beppe Grillo, still leads the polls. The party has no strong ideology but has in the past supported leaving the euro.”
Where now for the populist agenda?
“For some time now, politics has been the biggest risk facing European equities. However, unlike the crisis of 2011/12, financial institutions are much more aware of cross-border risks and better able to manage these. Political risks are never going to disappear entirely, but markets have become much better at pricing this risk. “
“Populism could fade if people who previously felt invisible now think they are at last being listened to. In many ways, the first 100 days of the Trump administration have not been especially encouraging for the populist agenda. If Macron can push through his reforms in France, then there is a good chance that optimism can replace pessimism.
“This could spread to other countries too: we note that Macron is very similar in many ways to Matteo Renzi in Italy. If Macron has success with his reformist agenda in France then this could provide a boost for Renzi, who resigned as prime minster after losing a referendum on constitutional change.”
What does Macron’s win mean for Brexit?
“Macron hasn’t said a great deal yet regarding his stance on Brexit. However, he is likely to seek to strengthen Europe’s institutions. We feel he will recognise the importance of the economic relationship between France and the UK and think he is unlikely to resort to protectionism.”
“We should add as well that Macron has some very experienced advisers in terms of European policy so he should be well-briefed on these matters. France and the UK have particularly close relationships as regards energy and defence. For that reason, France is likely to be a good partner for the UK in terms of Brexit talks. Clearly, the UK’s negotiation is with the EU, not with France, but these close ties on such significant issues should help prevent any major “accident” on Brexit.”
What are the implications for the European banking union and the impact on financial markets?
“Macron is in favour of greater integration so there should now be some progress on the banking union in Europe. A large part of the hold-up has been on the German side and relates to deposit insurance. Hopefully there will now be greater impetus to complete the banking union.”
“Germany was less keen on progressing with the banking union while countries such as France and Italy were lagging in terms of undertaking reforms. If Macron can push through his reformist agenda, with Italy to follow next year perhaps, then we could see more progress. In fact, there could be a significant unblocking of European policy if Macron, and potentially Renzi, could push through similar reforms at the same time.”
“Looking at equities, we note that bank shares have performed very well since the fourth quarter of 2016. Valuations have moved up but this election result should be a benign outcome for the sector.”
Was the result already priced in to markets?
“The stockmarket reaction so far today has been rather muted and certainly an element was already priced in after the first round vote. That said, a significant tail risk has now been removed. Given the strength of the corporate earnings recovery in Europe, we think the ongoing gains for European equities should continue.”
“In fixed income markets, the spread between French bonds and German Bunds should now return to fair value. As mentioned earlier, we think the “safety premium” enjoyed by Bunds and US Treasuries should now disappear.”
 A credit spread is the difference between the quoted rates of return on two different investments, usually of different credit qualities but similar maturities.