With the election of Emmanuel Macron as France's next president, the European Union breathes a sigh of relief, although the results of the National Assembly election in June will have a significant bearing on his ability to accomplish his political agenda. Yet even with this resolution in France, some degree of political uncertainty will persist as Europe's ongoing "super cycle" of elections continues, with votes in Germany and Italy on the horizon.
Mr. Macron's victory means France and the EU should be able to move past some of the more divisive issues raised during this presidential race, and investors can now start to focus on the positive economic story emerging in Europe:
- Mr. Macron is pro-euro and pro-European Union, and his victory is clearly a win for the EU - though it could make Brexit negotiations more difficult for the UK if France and Germany become more tightly allied.
- Mr. Macron's victory decreases the possibility of a "Frexit" from the EU and should prevent NATO from being further undermined.
- Ms. Le Pen's loss means a setback for the forces of nationalism in France, though her National Front party has developed a formidable amount of support. Anti-EU feelings can still resurface, particularly given that Mr. Macron remains a conventional, pro-establishment politician.
Two scenarios for Mr. Macron
Mr. Macron will need to cooperate closely with the incoming class of French legislators to have any hope of enacting significant policy changes. As such, we see two scenarios to consider after June's elections:
- President Macron's party does not gain a clear parliamentary majority. Unlike Germany, France has less experience forming political coalitions, which could limit Mr. Macron's ability to pass reforms. Under this scenario, which we believe is more likely, the markets would be uncertain about his room to manoeuvre.
- President Macron's party wins a parliamentary majority. As illustrated by the market's reaction immediately after the first round of presidential elections, this scenario should be bullish for euro-area risk assets, such as equities and bonds from the peripheral areas of the euro zone.
In general, Mr. Macron's victory and the accompanying rejection of euro-phobia should reduce some of the market's worries about political risks. This should help investors concentrate on the more positive economic side to the European story.
- Macroeconomic indicators. Unemployment numbers look much better than they did three years ago, and many economic indicators show positive signs. For example, recent purchasing managers index numbers show steadily improving manufacturing output in the euro zone.
- Interest rates. Despite some investors looking for higher rates in the immediate future, we don't expect to see a real change for at least 6-12 months. Indeed, we also don't expect the European Central Bank to begin tapering until 2018.
- The euro. The currency is likely to strengthen on the back of a better political outlook as well as better cyclical data and expectations of tapering in due course.
- Equities. There is a good chance that political risk will be priced out further. Based on our analysis, European equities - which have shown higher revenues and stronger order books and should continue to outperform global equities - will have further upside potential as political uncertainty declines.
- Fixed income. Our outlook for French government bonds is slightly positive. If Mr. Macron finds parliamentary support, we expect tighter credit spreads, a strong reduction of French-specific risk and tighter spreads in the euro-zone periphery; without it, we expect a mild risk appetite in fixed-income markets, with some event-driven spikes of volatility.
What's next for France - and Europe
While political developments make headlines that influence the financial markets, cyclical forces remain key drivers of performance. As long as the cyclical backdrop is positive, we should be in a good environment for risk assets - provided we don't get a clearly negative signal from the political realm. The outlook for monetary policy, both in the US and in the euro area, will also continue to be a key determinant for markets.
But politics continue to dominate much of the discussion for policymakers, voters and investors alike. We now expect the markets to turn some of their focus to Italy - the elephant in the room. It has an economy with weak growth rates, a weak banking sector and a governing party at risk of splitting up. If Italy does not hold a snap election this year, a regular election will be held in the spring of 2018. The risk of anti-European forces coming to power at either juncture is reasonably high.
Overall, however, Mr. Macron's victory brings with it the potential for a new and constructive agenda to be formed between France and Germany. This could help Europe move closer toward integration, and provide further reassurance for investors.