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France and Europe narrowly survived populism

The announced structural reforms and budget control would improve the long-term outlook for France. The ability of Macron to pass his reforms is contingent on the parliamentary election mid-June

Macron’s victory diminishes eurouncertainty
Macron gathered 66% of the votes in the second round of the French presidential elections - three points above the latest opinion polls. The market’s response was subdued on Monday, as Macron’s victory has already been priced in after the first round. The French - German government bond spread already tightened to 43bps last Friday ahead of the results from over 85bps prior to the first round, but still remain elevated compared to its pre-election level of ~30bps. We believe that the uncertainty around the ability of Macron to gain a majority in Parliament and pass his reforms will likely continue to keep French-German government bond spreads elevated until mid-June.

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After the US presidential election and the UK referendum on EU membership, where polls proved wrong, investors were overcautious on positioning according to polls ahead of the first round. Market’s participants only fully priced in the scenario of Macron winning the election after the first round as suggested by the strong rebound in the euro against the US dollar.

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Macron’s victory over Le Pen considerably reduces the risk of the collapse of Europe, which is positive for the economic outlook and the euro. In his victory speech, Macron emphasised his commitment to “defend and protect” Europe, which is likely to strengthen the relationship between France and Germany. Strong European cooperation is essential in the context of Brexit negotiations, the Greek bailout and a potential Italian banking crisis. However, the far right will remain the first party of the French delegation to the European Parliament with about 25% of the seats until 2019, which represents one major barrier to further European integration.

Results point to a divided electorate
The presidential election results reflect a divided French electorate, which makes changes difficult. One third of the French did not vote or returned blank ballot papers in the second round. Besides, the far right has become the main opposition party in France, with Le Pen obtaining 34% of the votes in the second round, which represents almost twice what her father got in 2002. The FN was ahead in just one department in the first round of the presidential election of 2012, while now taking the lead in 46 departments out of the 96 departments of metropolitan France in 2017, as illustrated in dark blue in the maps below. This rapid ascent of the far right between 2012 and 2017 could pose threat to the long-term outlook for France if President elect Macron fails to address the root causes of growing populism in France.

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Macron’s reforms to improve long-term outlook for France
As we approach the limits of what monetary policy alone can do, structural reforms remain the missing ingredients for growth in France.
Macron commits to reduce fiscal spending from 56% to 52% of GDP by 2022, close to the Eurozone’s average of 48.5%, in particular through cuts in the public servants staff and an increased control over the provision of social benefits. He aims to bring the budget deficit from 3.4% to the 3.0% of GDP threshold set by the European Union as early as this year-end, and reach 1% by 2022. Macron’s pledge to respect the European commitments is positive not only for the long-term outlook for France but also for Europe. Market participants generally see Macron’s fiscal conservatism as positive for the debt outlook for France, as reflected by the tightening of the French – German government bond yield spreads after Macron took the lead in the first round.
In order to boost growth, Macron has announced an investment plan of EUR50bn including EUR15bn for the “ecological transition” (i.e. towards a sustainable ecosystem) over the next five years, as well as increasing flexibility in the labour law and reducing corporate taxes from 33.3% to the 25% European average. On trade policies, Macron wants stricter anti-dumping rules at the European level while being in favour of free trade.
Overall, Macron’s reforms would only slightly increase French GDP growth (+0.4pp by 2022 according to Macron’s programme estimates) as budget control is likely to constrain growth in the short to medium term. However, the planned structural reforms are improving the long-term economic outlook for France.

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“En Marche!” to be the first party in Parliament
The next decisive step for France will be the Parliamentary elections to be held mid-June. The widespread disillusion of the traditional right and left parties is likely to be reflected in the legislative elections as well, with minorities gaining momentum in the Parliament.
Traditionally, the French give the majority in Parliamentary to the party of the President elect. However, this year’s political upheaval in the presidential election is increasing the uncertainty on Macron’s ability to get a majority in Parliament. The challenge for the relatively new centrist party "En Marche!" (EM) is to get an absolute majority of seats in Parliament so he can govern alone, without having to rely on the support of left and right parties. This is contingent to the resistance of the left in the constituencies of the West and the Centre of France, where Macron dominated in the presidential election. Alternatively, EM could become the first party in Parliament without obtaining the parliamentary majority and will need to engage into strategic partnerships with other parliamentary groups in order to implements his policies. Finally, the unlikely scenario is that EM and its partners may not get a majority in Parliament, leading to policy paralysis for the next five years. From a market perspective, the inherent fragility of a government without a majority in Parliament could lead to a deterioration of market confidence in the ability of the country to reduce its structural deficit and tackle its high level of unemployment, resulting in a higher sovereign risk premium for France.
According to Opinionway polls of 2 May 2017, EM is likely to be the first party in the Parliament although not with an absolute majority. Macron would gather 249 to 286 seats in the 577-seat Parliament, closely missing the required 289 seats for an outright majority. The Republicans are expected to take the second largest representation with 200 to 210 seats, ahead of the left with only 28 to 43 seats. On the other hand, while the FN is gaining momentum in Parliament, it is unlikely to obtain a significant share of seats to block EM’s policies. This likely centre-right majority in Parliament is increasing the chances for Macron to pass his liberal reforms on taxes, labour and budget.
Macron’s victory is a relief not only for France but also for Europe and the euro. We expect a likely centre-right parliament to reassure investors further in June on the capacity of France to implement structural reforms to boost its economic growth, amid large domestic social challenges.


Morgane Delledonne - Associate Director, Fixed Income Strategist - ETF Securities

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