What A Hollande Victory Means For The Euro

Includes: DRR, EUO
by: Macro and Cheese

As suggested by pre-election polling, Francois Hollande has won the French presidency. France will usher in a socialist president, the first since Francois Mitterrand, who surrendered the office 17 years ago. This will put France's new president at odds with Germany, the banker to the European economy, leaving Angela Merkel in the uncomfortable position of having to work with the opponent of the man she openly endorsed in the run-up to the election.

Before considering the election's impact on the markets, here is a review of the major planks of Hollande's platform:

  • Hire 60,000 new teachers
  • Balance budget by 2017
  • Tax income above EUR 1 million at 75%
  • Reduce usage of nuclear power
  • Reduce consumer utility bills
  • Lower retirement to 60 for those who have worked 41 years
  • Reduce payroll tax
  • Renegotiate European treaty
  • Separate commercial and investment banking
  • Encourage ECB to lend money directly to governments

For stocks the crosscurrents are numerous and complicated. In the negative column, Hollande brings with him considerable uncertainty, not only because Sarkozy was the "devil we know," but also because Hollande's campaign platform was contradictory, citing the need to spend, at the same time promising to balance the budget within 5 years. Furthermore, Hollande's promotion of the ECB aggressively buying government debt and ramping up deficit spending are similar to Europe's formula of the past decade.

On the plus side (at least as far as stocks are concerned), Hollande will kick things off by initiating a huge spending spree, hiring teachers, cutting payroll taxes, lowering retirement to the age of 60 for eligible workers, and cutting energy bills. Stocks have shown a penchant for rising to the occasion of more government spending, and this may be no exception. Because of the mix of forces at work, it is hard to handicap the net effect of the election on stocks.

However, history is much more clear about the effects of Hollande-like policies on currencies. Francois Mitterrand was elected president of France in 1981 on a platform remarkably similar to Hollande's--in fact, it would be a surprise if Hollande did not intentionally borrow from Mitterrand's page book to win this election. Following Mitterrand's victory, the French franc proceeded to lose half of its value against the dollar over the next few years.

French franc

(source: Bloomberg)

The euro is a strange currency, the sum of the disparate parts of the 17 countries that make up the Eurozone. The euro is brittle. It has no "give," no way to adjust for events unfolding in any one country. Not all of those 17 member countries are created equal, and the French slice represents about 20% of the pie.

As this post "goes to press," the euro is trading at 1.3025, down about 0.60 from Friday's close, and the lowest level in about three weeks. In all likelihood this is the first shot across the bow. Once the euro definitively breaks below 1.30, the trend will very probably gain momentum. For currency traders looking for a catalyst to move markets, this is as good as it gets.

Hollande's platform, as mentioned, is remarkably similar to that of his mentor, Francois Mitterrand. France's slice of the euro will weaken under the strain of increased government spending, just as did the French franc 30 years ago. If 20% of the euro were to come under pressure, the euro as a whole would very likely trend lower with it.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am short euro currency futures.