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Macron sets the cat among the pigeons

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Recent political elections across the globe have had extraordinary impacts on financial market sentiment. 

Macron’s victory in the French Presidential election has clearly calmed considerable market angst over the (albeit remote) chance of a Le Pen victory, and with it any threat to dismantle the EU or at least initiate a Frexit. Indeed, as foretold in the March edition of this commentary, the stars have somewhat aligned for the previously much-maligned EUR/USD. Slews of bank analysts are now reversing their expectations. Following on from the Trump reflation trade, Fed hikes and solid economic figures, USD strength apparently would never abate; meanwhile the common currency seemingly toiled from one crisis to the next. Amazing the change having a 39-year-old former banker at the head of the French government can have: government bond spreads (Fr-Gr) narrowed by 20bps immediately following the first-round vote on April 23rd, the CAC 40 keeps pressing its all-time highs, and at the time of writing EUR/USD is through 1.1100 the highest in 9 months.

The parallels between Macron and Trump’s election victories are interesting. Both men rose from relative political obscurity, without the backing of the traditional political elites and their corresponding parties, within a very short space of time, to capitalise on and capture sufficient votes of a thoroughly ideologically polarised electorate. Macron’s victory is seen as positive for the EU, and prevents the march of the far-right and Le Pen at least for the time being. The prospect of a Trump victory ex-ante, was feared across equity and currency markets; ex-post the so-called ‘Trump Reflation Trade’ provided bond markets with an almighty sell-off and sent equities and the USD soaring. There is symmetry with the behaviour of EUR/USD and Macron’s victory: this time it’s the EUR, not the USD, that is sought after. This move has also been helped by Trump’s inability to pass legislation through Congress to actually set about reflating the economy via fiscal spending - coupled with well-documented general bungling and shocking ineptitude, of course.

What, then, does Macron wish to achieve in France and Europe, and can he pass legislation to effect those changes?

The EU is clearly the focus of attention; Macron spent his first full day as president of France in Berlin visiting German Chancellor Merkel. Within the EU he has a raft of ambitions including, but not limited to, border control and defence, no doubt partially to placate Le Pen voters. Most interesting, and certainly not appealing to Le Pen voters, is his proposal to create a eurozone budget overseen by a eurozone finance minister. There’s unsurprisingly a general understanding across Europe that confidence in the single currency needs to be restored as much of the continent still has high unemployment. Berlin and Brussels are also likely to be keen to engage with the new president and his agenda. Two principal ideas are already under discussion and backed by Macron, the first of which being to use the eurozone’s established bailout fund, the European Stability Mechanism (ESM), to create so-called European Safe Bonds (ESB). These bonds would be securitised and issued directly by the ESM but backed by a pool of eurozone sovereign bonds. Issuing governments would remain responsible for their own liabilities, but ESBs could be guaranteed by the ESM, thereby jointly guaranteed by eurozone governments –  genuine Eurobonds. What isn’t clear at this stage is whether governments can collectively agree to ESBs with an ESM guarantee and, if the guarantee is not possible, whether investors will back the bonds. Concerns remain that the creation of large quantities of ESBs would crowd out demand for individual bonds of the eurozone’s weaker credits, thereby pushing up their funding costs, the exact opposite of the intention of the proposed scheme.

The second legislation under consideration is the creation of a Europe-wide unemployment insurance fund. The idea behind this is that those countries harder hit would be able to draw on the insurance fund to reclaim costs of higher unemployment. Given the eurozone’s divergent welfare systems and labour market rules, the idea seems politically challenging.

Before Macron can start to push these agendas he must also hope that his En Marche! movement can gain a significant number of seats in legislative elections in mid-June. If it can, he will have upended post-war French politics and will enjoy considerable power to push his agenda. Conversely, if En Marche! isn’t as successful as Macron himself, he will face being dependent on Republican and Socialist parliamentarians. These are the same people whose parties’ long-standing survival and reputation will likely depend on making sure his agenda is as uncompetitive as possible. 

With much political uncertainty on both sides of the Atlantic, it is surprising that the EUR/USD options market is implying levels of volatility that are the lowest since 2014. It would not be the first time that the market has been wrong-footed.

All views expressed here are the author’s own and are based on information available at the time of writing.

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