Author Archives: Olivier Desbarres

The Ultimate Guide to the 2017 French Elections – Part I

The first round of the French Presidential elections is due to be held in 47 days, with the likely second round two weeks later. There has already been much drama in a presidential campaign that has caught the world’s imagination.

The two-round election for the 577 deputies of the lower house of parliament on 11th and 18th June, which has so far received little attention, will complete the political picture in France.

There are currently eighteen presidential candidates spanning the breadth of the political spectrum, from the far-left to the far-right. Political jostling is in full swing with candidates forming alliances in a bid to capture the 46 million or so votes up for grabs in round one.

The National Front’s Marine Le Pen, currently ahead in the polls for the first round on around 27%, is looking to go one step further than her father Jean-Marie Le Pen and become the first ever French female president. She is currently under investigation for misappropriation of EU funds and publication of violent images.

The centre-left candidate Emmanuel Macron, aged 39, is second in the polls on around 25%. He is vying to become the first centrist president since Valéry Giscard d’Estaing in 1974, the first independent candidate to become France’s head of state and the youngest ever President under the Fifth Republic.

Republican candidate François Fillon, who comfortably won the party primaries, is third in the polls on around 20% despite the probability that he will face formal charges on 15th March of misappropriation of parliamentary funds.

President de Gaulle, in a nod to the heterogeneity of the French electorate, famously asked how it was possible to govern a country where 258 varieties of cheese exist[1]. This granular political landscape makes it that much harder to predict with any certainty the successor to incumbent President François Hollande who has opted not to run for a second term.

This in-depth four-part Election Series will examine all core elements of the upcoming presidential and legislative elections and take both a quantitative and qualitative approach.

The material, organised in easy-to-access questions and answers, will ultimately try to answer the key question of who will be President and Prime Minister and how this will impact France, Europe and financial markets. The British decision to leave the EU and US presidential elections have fuelled the notion that anything is possible.

In Part I, I examine the importance of French presidential and legislative elections, their mechanics and timelines and the implications of a potentially high voter turnout. Read more

French elections in focus but US data likely to draw attention

February is ending with a whimper rather than a bang. Market pricing for a Fed hike in March continues to flirt with 5-6bp while in the UK the market seems to be waiting for the government to trigger Article 50. Meanwhile the ECB is likely to stay in a holding pattern until it knows what kind of French president it will be facing come 7th May.

US ISM, income, spending, and inflation data out on 1 March could however potentially move the needle on financial markets.

I continue to expect a 25bp Fed hike in March but acknowledge that this is a low conviction forecast at this stage.

In France, the latest headline-grabber is that veteran centrist politician François Bayrou announced on the evening of 22nd February that he had opted not to run for the presidency. He will instead lend his support to Emmanuel Macron, the independent centrist candidate of the En Marche! Movement.

This should have come as little surprise but markets still reacted positively, with in particular French bond yields sliding lower.

The justification for this admittedly modest market reaction is that Bayrou’s electorate will now transfer its votes to Macron, in turn increasing the probability of Macron coming ahead of François Fillon and making it to a second round run-off against Marine Le Pen.

There is some logic to this argument, as recent polls suggest. Moreover, the relatively inexperienced Macron may benefit from Bayrou’s familiarity with the ins-and-outs of campaigning gained over three previous presidential election bids.

But there is also some evidence that Fillon, the Republican candidate, may benefit from Bayrou’s decision and it is simply too early to predict with confidence whether Macron or Fillon will make it to the second round.

The bottom line is that Bayrou’s decision has increased the odds of Macron and to a lesser extent Fillon making it to the second round and further decreased the odds of Le Pen winning in the second round against either Macron or Fillon.

Meanwhile, time is running out for Socialist Party candidate Benoit Hamon to secure a second round place.
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March Madness

Despite Donald Trump having been inaugurated as the 45th President of the United States only 28 days ago, saying that it has been an event-packed month is the under-statement of the decade.

However, as Randy Bachman sang in his number-one hit in 1974 – incidentally the year President Richard Nixon resigned following the Watergate scandal – “You Ain’t Seen Nothing Yet”.

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The common theme of low-wage growth

Weak wage growth runs through the many themes which markets are focussing on

The media and financial markets have tried to make sense of a number of key themes in the past twelve months, including:

  • The only modest rise in GDP global growth, major central banks’ reluctance to tighten monetary policy and the Fed’s glacial pace of rate hikes despite the improvement in the US labour market ;
  • Donald Trump’s surprise election victory in the November US presidential elections;
  • The Brexit referendum vote in the UK; and
  • The rise of nationalism and populism in Europe.

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US Federal Reserve back in the limelight

The whirlwind of Trump policies has taken the spotlight off the Federal Reserve’s path for monetary policy since its 14th December meeting at which it hiked rates 25bp.

Mixed US macro data and acute policy and economic uncertainty have likely cemented a pause at today’s Fed policy meeting, as priced in by the market.

However, today’s Fed meeting is significant as US yields and Dollar have edged lower year-to-date, in line with my expectations that the hawkish pendulum had maybe swung too far.

Moreover, today’s meeting – the first since President Trump was inaugurated – will see four new regional bank Presidents, with an arguably more dovish bias, take over from James Bullard, Esther George, Loretta Mester and Eric Rosengren.

I would expect the Fed’s policy statement to highlight the marginal strengthening in the labour market but also the slowdown in GDP growth in Q4, weak housing data in December and still very modest rise in inflation and inflationary expectations.

The Fed may also chose to emphasise the importance of domestic conditions, indicators and developments when setting interest rate policy, a very subtle nod to the increasingly acute uncertainty which the Fed currently faces.

Finally, the ten voting FOMC members are likely to unanimously vote in favour of rates remaining on hold.

I see no compelling reason why, at this juncture, the Fed would want to guide US yields (or the Dollar) beyond their year-to-date ranges. At the margin, the risk is that the Fed tries to stabilise yields, particularly at the long-end of the curve, with an eye on keeping open the possibility of a March rate hike.

Until the Fed has tangible evidence that macro policy-promises are being enacted and it has conducted an initial evaluation of these policies’ possible impact on the US economy, the Fed may disappoint market participants expecting a marked step-up in the hiking cycle from the one-a-year hikes delivered in 2015 and 2016.

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Tradespotting: Choose protectionism. Choose higher inflation. Choose weaker trade and growth

The future of global trade, which has slowed despite a pick-up in global GDP growth, is hogging the headlines, with the spotlight on both the US and UK.

US President Trump and his team have so far focused on (1) substituting US imports for domestic production, with Trump adopting a carrot-and-stick approach (2) trade in goods, particularly manufactured goods and (3) trade with China and regional trading partners and in particular Mexico.

There is in theory nothing irrational in President Trump wanting to boost domestic production and exports, narrow the $500bn trade deficit and spur US employment.

However, his current approach may in practise fall well short of delivering the improvement in US trade and jobs which he seeks. In a more extreme scenario, his tactics could at least in the near-term lead to higher US inflation and weaker trade, creating headwinds for both the US and global economy.

The high-labour cost US economy should be looking to better compete with the likes of Germany, not China. But the quality and desirability of exports matters.

The Dollar’s strength, over which the Trump administration has little or no control, will likely continue to weigh on the overall competitiveness of US exports while at the same time fuelling cheap US imports.

A stronger Renminbi is not the solution as exporting nations other than the US may be better positioned to capitalise on such a relative-price change, while the USD-cost of imports from China may rise.

If the US imposed higher tariffs on imports from China and other countries (such as Mexico), it would take time for US-based companies to boost production given insufficient quality and capacity in US manufacturing.

Moreover, China and other exporting nations such as Mexico and Canada may respond to higher US import tariffs by increasing their tariffs on imports from the US. This would put US exporters at a clear disadvantage vis-à-vis other exporting nations. Read more

Market fatigue in the face of catastrophic success

The relative stability in the Dollar, S&P 500 and US yields is broadly in line with my view that analysts and markets had got ahead of themselves with respect to the path of the US economy and financial markets.

Moreover, Chinese policy makers’ willingness and ability to use central bank FX reserves to support the Renminbi tallies with my expectation that “near-term, the PBoC may continue to see some value in a broadly stable Renminbi.”

Currency, equity and bond markets may also be suffering from “political-fatigue”, with Donald Trump’s “policy-by-tweets” exhibiting diminishing returns.

Expectations that Trump will have to deliver a more cohesive set of policy priorities will likely rise exponentially after his inauguration as President today. If he is unwilling or unable, markets’ good-will may flounder and the Dollar and US equities may correct lower.

In the UK, Theresa May’s speech was an important milestone in the UK’s already tortuous path towards a world outside the EU. But there are still many legal, political and economic hurdles the government must clear, including a number of parliamentary votes.

Given the uncertain path which British executive and legislative bodies will take to reach a difficult-to-predict outcome at a still unidentifiable point in the future, fluctuations in Sterling will likely remain common-place.

I see the risk tilted towards Sterling weakness due to the British government’s acute challenge of negotiating favourable trade deals with EU and non-EU countries and the UK economy’s reliance on faltering household consumption growth.
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Sterling singing to (leaked) tune ahead of Theresa May speech

Reports in the British press about the content of Theresa May’s planned speech tomorrow seem to confirm that the prime minister may sacrifice access to the Single Market in exchange for control over EU immigration into the UK.

Unsurprisingly perhaps, Sterling has weakened further but the currency may get some (temporary) respite if the content of Theresa May’s actual speech is somewhat more conciliatory.

In particular I would expect markets to focus on whether the UK government has moved closer to agreeing to a transitional arrangement once the UK has actually left the EU and whether any progress has been made in protecting the all-important UK services sector.

About 45% of the UK’s total exports are destined to the other 27 EU member states and about 53% of its total imports come from the EU. In comparison, only about 9% of the EU-27 exports of goods and services are destined for the UK. Similarly, only 9% of the EU-27 imports of goods and services come from the UK.

The EU thus has far more leverage over the UK than vice-versa assuming these 27 EU member states are willing and able to negotiate as one trading block, in my view. This imbalance is even greater in traded goods alone.

However, when it comes to services, the picture is somewhat more balanced and the UK may arguably have a stronger bargaining hand.

Simply put the EU buys and sells a far greater share of its services to/from the UK than it does for goods and it may be difficult for EU countries to substitute imports of financial services from the UK given London’s pre-eminence as a financial centre. Read more

UK inching towards Brexit

British Prime Minister Theresa May will make a speech on Tuesday 17th January in which she will set out in greater details her plans for the UK’s exit from the EU.

There have been few signs that she is willing to tone down her mantra of the UK regaining control over immigration in exchange for a bespoke trading deal with the EU which may exclude access to the Single Market.

If Theresa May sticks to her guns next week I would expect Sterling to weaken further.

A sell-off in Sterling could be partly curbed if Prime Minister May agrees more explicitly to a transition agreement whereby the UK still retains some of the benefits of EU membership even after the UK has officially left the EU.

If MPs perceive Theresa May’s speech as insufficiently detailed or it is not backed up with a detailed and formal government white paper, parliament may decide to delay or even scupper the process by which Article 50 is triggered.

This would at the margin increase the perceived odds of the UK remaining in the EU and may provide some relief for Sterling.

However, I would view this as only a temporary reprieve as ultimately the government has a popular mandate for the UK to leave the EU.

The apparent resilience of British economic growth since the June referendum has given weight to the arguments that the economy can easily weather the UK’s exit from the EU and that the British government is in a strong negotiating position.

However, the risk now is perhaps that too much confidence is being placed in the British economy’s ability to weather a number of possible forthcoming challenges. Read more

Chinese Renminbi – Squaring the circle

China’s exchange rate policy is one of many significant uncertainties or “known-unknowns” for 2017 (as it arguably was in 2016 and prior years).

The market’s focus is still very much on the rise in USD-CNY but Chinese policy-makers are keen to emphasise the importance of the Renminbi’s performance against a basket of currencies – the CNY Nominal Effective Exchange Rate (NEER). This comes as no surprise.

The monthly pace of CNY NEER appreciation or depreciation has rarely exceeded 3% in the past seven years, suggesting that policy-makers have sought to control the Renminbi’s rate of change.

Large (and well documented) capital outflows from China have been the main source of Renminbi pressure but China’s current account surplus-to-GDP ratio has also edged lower to around 2.5% due to a rising deficit in the services balance. This perhaps dents the argument that the Renminbi is still materially undervalued.

Moreover, despite the Renminbi’s gain in competitiveness in the past year, China’s trade surplus has somewhat counter-intuitively shrunk, not increased. This may be due to price effects outweighing demand-effects (for exports) and still strong credit-fuelled Chinese imports.

In response to quarterly capital outflows of between $100bn and $200bn since late 2015, the PBoC intervened in the FX market to the tune of about $280bn in January-November.

This strong commitment likely reflects the perceived economic and geopolitical benefits of limiting the Renminbi’s depreciation.

Near-term, I think the PBoC may continue to see some value in a broadly stable Renminbi or only very modest CNY NEER depreciation. If capital outflows re-accelerate this would likely require the introduction of further capital controls and aggressive FX intervention. This is certainly an option in the short-run.

If capital outflows stabilise or recede, the PBoC may be able to slow or even stop FX intervention. This is not a totally unfeasible scenario if global yields stabilise and a slightly stronger CNY attracts capital back into China or if capital controls take greater effect.

In the more unlikely scenario whereby China experiences capital inflows, which last happened in Q1 2014, I would expect the PBoC to have limited appetite for rapid and/or sustained Renminbi appreciation and instead use this opportunity to rebuild FX reserves.

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