Special Flash: French elections

Market analysis - 4/24/2017

A bright spring in store for Europe

The French presidential race has been marked by one dramatic turn after another in recent months – even before the actual campaign had begun. Even as election day drew near, it was impossible to completely rule out the possibility of a second round battle between Marine Le Pen and Jean-Luc Mélenchon, which caused us to moderate our positions. 

With a 7 May duel now looming between Emmanuel Macron and Marine Le Pen, the National Front’s having fared worse than in elections of the past three years, and the announcement, almost immediately after the results were announced yesterday evening, that the main political movements eliminated in the first round would not be lining up behind Marine Le Pen, we believe that political risk has now receded into the background. From the start of this year, we had stressed the differences between this election and the two blockbuster votes of 2016 in the UK and the US. Namely, a two-round election and a far right candidate with few extra votes to count on in two weeks’ time. While keeping an eye on the campaign’s homestretch and on all the events that could still influence the final outcome, it is now time to refocus on the euro zone’s current macro and micro fundamentals. 

And those fundamentals are solid. The latest PMI leading indicators are at a seven-year high and show that growth is in line with our best-case scenario and continues to gather strength. Monetary policy is stable and accommodating, and earnings forecasts are being revised upward for 2017. Meanwhile, a Macron victory would boost the Franco-German duo and strengthen the euro zone. This would, in turn, help the euro zone’s banking sector further down the road to recovery and reinforce the euro zone’s ability to implement economic policies suited to its specific needs. European political risk will now shift towards the Italian vote scheduled for 2018.

Although the outcome of the first round was as opinion polls had suggested, the markets’ initial reaction is still a sigh of relief. The euro is up against all currencies, while the Swiss franc and the yen – traditional safe havens for currency traders – are down. Yields on the top-rated countries are rising slightly. Credit spreads are narrowing, and euro zone equity markets are up sharply. Implied volatility on the European equity markets is down appreciably. So the coming weeks are likely to see a return of investors, non-residents in particular, to European equities, and especially to France. 

So these should clearly be overweighted in a global equity portfolio. In European bonds, we can look forward to a narrowing in the OAT/Bund spread, most of which should result from a rise in core yields. Conversely, we will be overweighting financial subordinates and convertibles. Springtime 2017 looks very promising indeed for European risky assets.

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