Macron vs Marine

25 Apr 2017

After all the soul searching of recent weeks, the result of the first round of the French presidential elections was as we expected: Emmanuel Macron made it through to the second round. In our view, the question this past week has been who would join him. The answer is Marine Le Pen. As for the rest, François Fillon and Jean-Luc Mélenchon lagged behind Macron and Le Pen, and Benoît Hamon fared as badly as the polls predicted he might.

In this commentary, we cover:

  • Market reaction
  • Timeline: from here to inauguration
  • Parliamentary elections: cohabitation time
  • The paths to Frexit
  • The European dimension

The market reaction

While we are confident that Macron will win the second round, we suspect that some investors remain concerned that Le Pen could win – although that could of course create an opportunity. However, many if not most investors will probably take comfort from the fact that Mélenchon did not make it through to the second round, because the Macron vs. Le Pen race is more of a known quantity. The euro appreciated as news of the result first started coming in, but it then gave up some of that appreciation on Monday. Indeed, before the election, market concerns about the risk of a Le Pen or Mélenchon victory had been most apparent in the price of French government bonds: the OAT-Bund spread had widened materially. Elsewhere it had been difficult to convincingly identify evidence of mounting concerns about potential outcomes in the French election in other asset prices. On that basis, if Macron does win the runoff on 7 May, we should expect the principal market reaction to be a spread compression in the rates market – with a 30 basis point spread achievable – but that may not arise until Macron’s victory is officially declared. In the meantime, if the market does not fast forward to a Macron victory, it is possible that investors might start to consider the likelihood of Le Pen being able to implement her radical agenda if she wins. Here the conclusions are a little less clear, as we explain below: we agree that President Le Pen would find it extremely difficult to implement much of her agenda but the parliamentary hurdle to holding a referendum on membership of the Eurozone is not as formidable as some claim. The real constraint on Frexit is public opinion.

The timeline: from here to inauguration

Although the outcome does not look in doubt, the official result of the first round will not be declared until Wednesday 26 April with the campaign for the second round not officially beginning until Friday 28 April. There is a televised debate scheduled for Wednesday 3 May and the campaign for the second round formally closes on Friday 5 May, after which there will be no more opinion polls. France will then go back to the polls on 7 May. For all the focus on France, there are two other important events in Europe that will occur during the brief campaign for the second round. First, on 27 April there is the European Central Bank (ECB) policy meeting and press conference; and, second, on 30 April the results of the leadership election for the Democratic Party in Italy will be announced. We anticipate that the two key inter-related themes of the second half of this year will be ECB exit and political risk in Italy. These two events are important signposts for those themes, with perhaps President Draghi’s last opportunity to sound dove-ish and the likely election of Renzi, who still appears to be keen on early elections and ‘winner takes all’ election systems but has apparently lost faith in fiscal prudence.

Parliamentary elections: cohabitation time

Following hot on the heels of the presidential election in France comes the first and second round of elections for the lower house of the French parliament on 11 and 18 June. The outcome of those elections is critical because a president relies on parliamentary support to implement his or her agenda. Under the current circumstances of a Macron vs. Le Pen second round, there is every prospect that France is in for another experience of ‘cohabitation’ where the president is not from the party that enjoys the majority in the Assembly. As before, it is the prime minister – rather than the president – who calls the shots in that situation. To be fair, it is not easy to predict the likely composition of the Assembly. What we do know is that only those candidates who win the support of 12.5% of the registered voters in a constituency can make it through to the second round, and then it’s winner takes all. In the past, this system has worked against Le Pen’s National Front, but support for the party has probably risen far enough to start translating into representation in the Assembly. Previously, the French electorate has rewarded the president with increased support for his candidates to give him a helping hand but it is unclear whether either of the current presidential candidates can expect to benefit from that electoral dividend. So if your focus is the domestic policy agenda and the implementation of fiscal and structural policies, then there is a significant risk of grid-lock. However by the same token it is hard to see how Le Pen could implement much of her extreme agenda. Macron should be in a better place to work with the Assembly than Le Pen, but that is not the same thing as being able to deliver his agenda. Indeed, we know very little about the selection and electoral prospects of the large numbers of ‘newcomers’ from civil society that Macron wants to run under his En Marche! banner in the parliamentary elections.

The paths to Frexit

The key issue for investors in this election – although probably not for those who actually voted – is the risk of France leaving the Eurozone, or Frexit. Two of the four candidates who had a plausible chance of making it through to the second round – Le Pen and Mélenchon – were both effectively in favour of France leaving the Eurozone and the European Union, if you assume that neither would be able to gain support for the radical reforms that might leave them comfortable with remaining. However, it is often claimed that it would be impossible for either candidate to hold a referendum on France’s membership of the Eurozone, because under Article 89 of the French constitution, the president would require support from both houses of parliament and that was always going to be beyond the reach of either Le Pen or Mélenchon. However, there is another potential path to a referendum, via Article 11, which was famously exploited by Charles de Gaulle. There are different hurdles a president would have to clear to use article 11, which we will not delve into here. In short, we think that the focus on Article 89 is probably complacent. However, holding a referendum is one thing; winning one is another and we believe that the fundamental barrier to France leaving the Eurozone is public opinion, which unlike in Italy, still looks solidly in support of ‘remain’, and not the constitution.

The European dimension

The focus going forward will be on the second round and what domestic reforms Macron will enact if he is elected. However, we continue to believe that Macron could be an important figure on the European stage. Macron has repeatedly stressed that he wants to relaunch the European project and urged hope in Europe in his victory speech. The Franco-German axis has always been the driving force in the European project. The election of an unashamedly pro-European French president who might be willing to expend political capital to make progress could act as a catalyst for ever closer union. It is very early days to talk about a decisive move towards fiscal union but the election of Macron would clearly increase the probability of progress towards that goal.
Download to read more