Markets buoyed and relieved by French vote, but further volatility expected

24 Apr 2017

France’s centrist candidate Emmanuel Macron will go head-to-head with far-right Front National leader Marine Le Pen in the second round of the presidential election in a development widely regarded as a relief by markets, but investors have been warned that Europe has further hurdles to overcome.

In first round voting on Sunday, Macron received 23.8% of the vote against Le Pen’s 21.4%, meaning the pair will face each other in the second round on 7 May.

The other main challengers, centre-right candidate François Fillon and hard-left Jean-Luc Mélenchon, fell out of contention after polling just over 19% each. Elsewhere, Socialist candidate Benoît Hamon polled just 6.4% of the vote.

Markets were buoyed by the result with the CAC 40 index of French shares up about 3.5% on Monday morning. Elsewhere, the euro jumped to a five-month high having risen more than 2% against the dollar since last week.

Opinion polls are forecasting a significant victory for Macron in the next stage, as he has already received an endorsement from Fillon and Hamon. This opens up the possibility of an alliance between socialists and republicans/gaullists being formed in the run-off election to oppose Le Pen’s party.

Many believe the result has significantly reduced the level of political risk in Europe, particularly given Macron’s pro-European Union (EU) and business stance, while others are quick to point out there are still hurdles to overcome on the Continent.

A reduction in political risk

Schroders senior European economist Azad Zangana described the result as “good news” for investors because Macron will not only help stabilise the EU but also help build stronger support mechanisms.

“Compared to Le Pen, who wants to take France out of the euro, he is by far the preferred candidate,” he said. “The campaigns will now pit the two lead candidates against one another, which we expect will mean a debate not along the usual left-right political debate, but based on inward vs. outward-looking France.

“The contest is not over yet, but investors are likely to take comfort and to begin to think about the more attractive valuations that European equities offer – a market that has struggled to keep up with the global reflation trade due to political uncertainty.”

The Blackrock Investment Institute said the result should lead to a material reduction in perceived political risk in Europe. The institute is therefore positive on European shares and expects the risk premium to linger until legislative elections in June.

A note issued by the institute, read: “Europe stands to benefit from global reflation, and we see attractive valuations in cyclical shares. We see French government bonds recovering relative to their German bund counterparts, shrinking yield spreads.

“At the same time, we expect safe-haven bund yields to reverse some of their recent drops and yields overall to climb. We are underweight European fixed income due to risks that the improving economic outlook will spur higher bond yields and wider spreads on investment-grade corporate bonds – especially if markets sense the European Central Bank is moving toward winding back its asset purchases.”

But don’t open the champagne just yet

However, Royal London Asset Management head of multi-asset Trevor Greetham warned investors not to get carried away, noting the French election is likely to be the first of several risks to test markets as summer trading approaches.

He added: “Signs of a temporary peaking out in global growth, the impact of tightening moves in China and, first up, a potential government shutdown in the US at the end of this week, mean investors can’t pop the champagne corks just yet.”

Elsewhere, Neuberger Berman senior portfolio manager for European high yield strategies, Andrew Wilmont, said Le Pen’s strong showing will keep investors on their toes as they nervously await the outcome of the second round.

He added that as a result European government bonds and risky assets in Europe are likely to be jumpy over the next two weeks. Currencies may also experience some volatility – at least in the short term – particularly ahead of the recently announced snap election in the UK on 8 June.

“More generally, our base case scenario for Europe remains positive,” Wilmot added. “It has been enjoying a gradual recovery, supported by continued growth, low interest rates, an undervalued currency, and a gradual tick-up in consumer and business confidence. Overall, we are biased toward European equities over bonds and within bond markets, we prefer credit over government issues.”

BMO Asset Management chief economist Steven Bell said a serious hurdle has been overcome following the first round vote and he expects European equities to perform strongly from here.

“Europe has the prospect of several years of above trend growth with interest rates and inflation staying low,” he said. “After years of disappointment, 2017 may be Europe’s year.”

However, Bell added there are still problems with the European project, noting the populist Five Star Movement could still gain power in Italy next year and unemployment remains far too high in many countries.

He said: “Bund yields will rise but they remain exceptionally low and peripheral spreads are set to narrow. The euro has bounced but the extent of its rise will be limited by positioning, as there were a few large positions still left short the euro.”




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