Macron And Le Pen Move To The 2nd Round: What Happens Next, According To Goldman And Citi

Most of the results are in, and while it remains close, Macron will likely be the winner of the first French presidential round and is set to face Marine Le Pen in the runoff.

What does that mean for various asset markets and the bigger macro picture?  Here are two forecasts, just released from Goldman and Citi.

First, Goldman Sachs:

  • Emmanuel Macron will face Marine Le Pen in the run-off of the Presidential election on May 7, according to exit polls. We maintain our view that mainstream candidate Mr. Macron will likely win the French Presidential election.
    • In the two week-period before the run-off, both Mr. Macron and Ms. Le Pen will resume their campaign. A televised debate between both candidates will be held on May 3 (9pm Paris time).
    • Polls carried out prior to the outcome of the first round indicate that Mr. Macron has a 25pp lead over Mr. Le Pen. Reflecting France’s political realignment between mainstream pro-European and populist Eurosceptic voters, we expect the gap in polls between Mr. Macron and Ms. Le Pen to widen in favour of Mr. Macron in the run-up to the second round.
    • We expect the ECB to maintain its existing refinancing facilities (namely the fixed-rate full allotment (FRFA) and the emergency liquidity provision (ELA) via the Bank of France) in the coming weeks, to sustain market functioning and continuity of pricing in the systematically relevant market segments. In the face of a politically-induced spread widening, this is also likely to be accommodated through its asset-purchase programmes, as long as it proves to be temporary.
  • We think the equity market has already largely priced the outcome and concerns about the elections have not prevented European equities and the CAC 40 from performing well on an absolute basis since the beginning of the year (+5% YTD for both).
    • We expect European equities to remain broadly flat during the two rounds of the election given that the outcome of the first round corresponds to what was broadly expected, and given that the probability of Ms. Le Pen winning the election cannot be completely ruled out.
    • While we think Emmanuel Macron will win the presidential election on 7 May, we think this outcome has the potential to lift European equities only slightly (about +2%-3%), given our view that very little 'election risk premium' has been discounted in European equities (unlike in the bond and the equity derivatives markets).
    • The French election has not prevented European equities and the CAC 40 from performing well on an absolute basis since the beginning of the year (+5% YTD for both). Likewise, the performance of European equities versus the US has reflected pretty accurately the positive moves in fundamentals. Europe has seen inflows from US investors (after a year of selling in 2016) and has started to outperform the US.
    • Since the beginning of the year, the equity risk premium has declined by 40bp in Europe, while it has risen by 50bp in the US.
    • ‌There is also evidence that European equities have moved in line with economic fundamental data, as they have recently started to outperform the US when earnings expectations have started to rise more rapidly in Europe than in the US
    • ‌In the event Ms. Le Pen is elected in the second round (not our base case), European equities would be particularly vulnerable given how little this scenario seems to have been discounted.
    • We estimate that the equity derivatives market is pricing a 5% absolute move for the SX5E for the election. Based on our assumption that it reflects a 20% probability of Ms. Le Pen being elected, it implies a 12% downside move for the SX5E and a 15%-16% downside move for the FTSE MIB and the CAC 40 if this scenario were to materialise.
  • We expect today's results to generate some relief for the FTSE MIB, French and Italian banks and a very minor relief for the CAC 40. That said, as this has largely been the central expectation priced into the markets, we would expect any rally to be modest. French domestic stocks and the CAC 40 have not underperformed significantly as of late, and we do not expect them to rally materially following today's results, or after the second round of the election.
    • That said, as this has largely been the central expectation priced into the markets, we would expect any rally to be modest
    • French domestic stocks and the CAC 40 have not underperformed significantly as of late and we do not expect them to rally materially following today's results, or after the second round of the election.
  • In rates space, French bonds had incorporated some political risk premium, and traded more idiosyncratically. We expect the 10-year OAT-Bund spread to narrow by as much as 15bp on short covering, to around 50-55bp – or within 1 standard standard deviation above our macro-econometric model measure of 'fair value'. We would expect the daily correlation with German Bunds to remain somewhat below the 90% observed since the beginning of the ECB's PSPP on account of residual uncertainties in the run-up to the second round. We would expect a similar re-pricing in intra-EMU spreads in the periphery markets, where BTPs and Bonos spreads to Bunds could go back to trading closer to a range of 170-190bp in the coming weeks (from around 200bp on Friday's close) and 120-130bp (from around 140bp on Friday) respectively. We think that political uncertainty around the Italian political outlook will weigh on BTPs.
  • Our FX analysis suggests that a sizeable decrease (to close to 0 percent) in the probability that investors assign to Ms. Le Pen becoming President, or to a break-up of the Euro area, that is close to its lows in July 2014 could push the EUR higher versus the USD and the JPY, pushing EUR/USD close to 1.13.
    • That said, how positive and persistent the market reaction will be after the election will depend on other factors, including the economic and inflation outlook and communication from the ECB at this week meeting and other central banks on the near-term policy stance. Political uncertainty and the threat of a break-up of the Euro area will remain a latent risk that is likely to resurface at times, with the next pressure point being the Italian elections, which are likely to take place in 2018Q1.

And here is Citi's take:

Polls were right: preliminary results show Macron and Le Pen through to the second round: According to partial estimates based on votes counted social liberal Emmanuel Macron (~24%) and Far Right Marine Le Pen (~22%) are through to the second round of the French presidential election to be held on 7 May. Fillon and Mélenchon are joint third (~20%), while Hamon came in a distant fifth place with ~6%. We expect Macron to win the second round and to become the next French president, on the basis that the candidate closest to the centre of the political spectrum has the best chance to win.

Narrow gap between the top four candidates: The gap between the top two candidates is ~2pp, while the gap between second and third/fourth place was 2pp, meaning that the top four are within the four points indicated by the average of polls before the election. These small margins imply potential risks in terms of legitimacy.

Turnout was on the low side: Estimates of turnout are around 77%, compared to the 79.5% in the first round in 2012 and 83.8% in 2007. We know from the 2007 and 2012 Presidential elections that while the turnout typically increases between the two rounds, the number of valid ballots drops by around 1 million. Some voters choose to deface their ballot, perhaps expressing their frustration about having to make a choice between two finalists that they don’t have much affinity for. In 2002, however, the number of valid ballots rose by 2.5mn in the second round between Le Pen's father and Chirac, showing that the prospect of a National Front President mobilised mainstream voters. For the second round in two weeks, we expect turnout to be slightly higher (but the number of valid ballots to be lower) in keeping with the historical trend.

Declarations of support from defeated candidates are important: Fillon has announced his support for Macron (on the grounds that voters should do not abstain, and vote against Le Pen and therefore in favour of Macron). Hamon is also supporting Macron while Mélenchon has not said anything yet, but seems unlikely to support the National Front.

‎The margin of victory for Macron in the second round is likely to be sizeable – Our calculations show that the likely gap between the finalists in the second round could be around 25% (62.5% vs. 37.5%), assuming that Le Pen could convince around 35% of undecided voters to cast a ballot in her favour. Even if Le Pen managed to convince 100% of the 6.2mn of undecided voters (according to the various scenarios tested for the second round), Le Pen would still fail to defeat Macron and create a surprise in the second round. Note that an average of eight polls testing the second round combination of Macron vs. Le Pen showed that Macron would be on 63.5% to Le Pen’s 36.5%, with 21% of voters undecided.

  • June legislative elections likely to yield co-habitation – Based on the relative share of the mainstream Left vs. Mainstream Right, the most likely outcome of the legislative elections (11 & 18 June) would be a ‘co-habitation’, meaning that Macron might have to choose a probable centre-right Prime Minister supported by the reformist part of the Socialist Party.
  • A newly elected President Macron would likely be able to carry out some of his reforms, but political fragmentation could be an issue – We suspect that the strict deficit targeting approach championed by Macron would be implemented, and that the government would be able to push on relatively quickly with its reform of the public sector, albeit not on the scale favoured by the Right. Co-habitation would probably take some getting used to and lead to increased uncertainty in the first few months of governing. This might dampen business confidence somewhat.
  • Economic baseline to be marginally adjusted – Based on the issues discussed above, we might be tempted to shave a couple of decimal points off our 2017-18 real GDP growth trajectory in the next forecast round (currently 1.4% 2017F, 1.7% 2018F), but acknowledge that there are also some upside risks to our forecasts based on stronger surveys.
  • Relationship with Germany likely to be strengthened – A Macron presidency could mean potentially a strengthened relationship with Berlin, especially if Martin Schulz were to become the next German Chancellor in the Federal elections to be held in September.
  • The future of Europe now looks more stable given a likely mainstream win – This French presidential election has the potential to have far-reaching consequences for Europe. Given Macron’s pro-EU platform, the outlook for Europe ought to be strengthened, in our view. The Italian election (likely to be held in February 2018), is the next big political risk for Europe
  • Next steps: polls for the second round will restart on Monday, as will the campaign. The next and final televised debate will be held on Wed 3 May, co-organised by TF1 and France2.