Fed 25 and 500 Godfathers

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Baring calamitous February inflation and retail sales data, I expect the Fed to hike rates 25bp on 15th March for the second time in three months, in line with market pricing and my mid-February forecast.

While underlying US inflation has only edged up slowly and payroll growth remains modest, other US data have been reasonably buoyant. The pool of available labour continues to grind lower and regional indicators, national confidence surveys and housing data pushed higher in January-February.

Moreover, normally dovish FOMC members have not made a strong case for a March pause and, along with Chairperson Yellen, have seemingly for now at least not made the Fed hiking cycle conditional on Trump delivering on his promise to loosen fiscal policy.

The big question is what next for the Fed. Its updated forecasts and dot-chart and Yellen’s question-and-answer session will undoubtedly provide some extra colour.

But it may be a little premature for the 17 FOMC members to materially change their forecast for the appropriate pace of hikes for 2017, which stands at 74bps – broadly in line with current market pricing.

The risk to my turn-of-the-year forecast that the Fed may only deliver two hikes this year is probably to the upside. But if the Fed is going to hike once a quarter, it will want to prepare markets conditioned by years of hikes far more modest than predicated by the Fed.

In France, potential presidential candidates have only a week left to meet the Constitutional requirements to become an official candidate in the first round.

My core scenario remains that Fillon will remain in the presidential race, that the first and second rounds due on 23rd April and 7th May will not be pushed back, that Le Pen and Macron will likely make it to the second round run-off and that Le Pen will lose the second round whether she faces Macron or Fillon.

But one should at least entertain the possibility, even if remote, that Jean-Luc Mélenchon, currently fifth in the polls on 12%, will not meet the requirements to be a candidate in the first round – namely the written support of 500 elected sponsors – which could in turn boost support for Socialist candidate Benoit Hamon.

Moreover, it is still conceivable, albeit unlikely, that Fillon will make it to the second round or conversely pull out of the race with Alain Juppé filling his place. Finally, the possibility of this year’s elections being postponed, while extremely slim, merits discussion.

 

Fed will probably hike 25bp next week and real question is what next

The US Federal Reserve (Fed) will on 15th March hold its second policy meeting of the year and markets have fully priced in a 25bp hike. Baring a calamitous set of CPI-inflation and retail sales data for February (due hours before the Fed meeting), I expect the Fed to hike rates next week for the second time in three months, in line with my mid-February forecast (see March Madness, 17 February 2017).

At the turn of the year, I had expected the risk to be biased toward the Fed being somewhat more dovish than the FOMC members’ dot chart prediction of three hikes in 2017. This view was premised on inflation not rising as fast expected due to lags in the implementation of Trump’s planned fiscal policy loosening and immigration curbs, residual slack in the US labour market and the disinflationary impact of higher US yields and a stronger dollar (see Hawkish pendulum may have swung too far, 21 December 2016). Moreover, my expectation was that the four new voting FOMC members would be more dovish than the four members they replaced.

The rise in underlying US inflation measures has been modest rather than spectacular, as depicted in Figure 1.

 

olivier desbarres godfather fig 1 and 2

 

Moreover, while the pool of available labour has edged lower in recent months (according to my estimates), aggregate payroll growth in the private sector remains modest at around 4% year-on-year and around 2% yoy when adjusted for headline CPI-inflation (see Figure 3). Modest real wage growth remains an issue in the US, but also the UK, eurozone and Australia (see The common theme of low-wage growth, 10 February 2017).

 

olivier desbarres godfather fig 3

 

However, US data macro data have on the whole been reasonably buoyant, with in particular regional indicators, national confidence surveys and housing data pushing higher in January-February (see March Madness, 17 February 2017). Data, in particular global manufacturing ISM numbers for January and February, also paint a picture of a slow rise in global GDP growth to around 3.0% yoy in Q1 2017 from around 2.8% yoy in Q3 2016 – an admittedly unspectacular growth rate by historical standards but a far cry from the predictions of a global recession (see Figure 2).

It is also striking, in my view, that FOMC members usually regarded as dovish, have either sat on the fence or even taken a slightly hawkish stance. Finally, Chairperson Yellen and other voting members have (consciously I suspect) made little reference to President Trump’s planned fiscal loosening and other policy measures. This suggests to me that the Fed, in the near-term at least, sees sufficient reason to hike policy rates regardless of whether and when Trump delivers on his promises to cut taxes and boost infrastructural spending.

 

Fed will need to tread a clever path following a likely second hike in 3 months next week

Assuming that the Fed hikes 25bp next week, taking its policy rate to 0.75-1.00%, the big question will be whether the Fed maintains a one-a-quarter hiking cycle (and therefore delivers four hikes in 2017), sticks to its appropriate policy rate forecast of three hikes or pauses for long periods of time in between meetings and hikes fewer than three times in 2017 (the latter would be in line with my late-2016 forecast). The Fed’s updated forecasts and dot-chart and Chairperson Yellen’s question-and-answer session will undoubtedly provide some extra colour.

However, it may be a little premature for the 17 FOMC members to materially change their forecasts for the appropriate policy rate at end-2017, which on a weighted average basis currently amounts to 74bps (see Figure 4). There is ultimately an endless list of factors which could see the Fed sticking to a more gradual pace of rate hikes, including a tightening of US monetary conditions in excess of the rise in the Fed fund rate (brought on by higher US yields and/or a stronger dollar), a pronounced correction in US and global equity markets and a far less ambitious timetable by the Trump administration for the loosening of fiscal policy.

So far, US government bond yields have risen by less than 25bps since the Fed hiked policy rates on 14th December 2016 and the US Dollar Nominal Effective Exchange Rate (NEER) has weakened about 0.5% according to my estimates (see Figure 5). Moreover US equities are up about 4% in that time. The risk to my turn-of-the-year forecast that the Fed may only deliver two hikes this year is probably to the upside and for the first time in many years the Fed may actually deliver the number of hikes it had premised (74bp) and which the market is currently pricing in (71bps). But if the Fed is going to hike four (or more) times this year, it will want to prepare financial markets which have in recent months tended to perhaps under-estimate the scope for Fed tightening.

 

olivier desbarres godfather fig 4 and 5

 

French presidential elections – Black swans still hovering

Analysis of the forthcoming French Presidential elections has understandably focused on who ultimately will become France’s head of state, on the assumption that:

1) The main potential candidates, Emmanuel Macron (independent, centre-left), Marine Le Pen (National Front), François Fillon (Republican Party), Benoît Hamon (Socialist Party) and Jean-Luc Mélenchon (Far Left) will likely make it to the first round; and

2) The dates of the first and likely second round (23rd April and 7th May, respectively) are cast in stone (see Figure 6);

 

olivier desbarres godfather fig 6

 

These are reasonable assumptions to make, based on precedent. My core scenario remains that Fillon will remain in the presidential race, that the dates for the first and second round will not be moved, that Le Pen and Macron will likely make it to the second round run-off and that Le Pen will lose the second round whether she faces Macron or Fillon. But one should at least entertain the possibility, even if remote, that:

  1. Jean-Luc Mélenchon, currently fifth in popular opinion polls on 12% support, will not meet the Constitutional requirements to be a candidate in the first round as detailed in Figure 7, which could in turn boost support for Hamon.
  1. Fillon will make it to the second round;
  1. Conversely, Fillon could still pull out of the race and Alain Juppé fill his place; and
  1. This year’s elections are postponed.

 

Sponsors – First hurdle to becoming an official candidate for the first round of the presidentials

The issue of sponsors receives very little attention in the international press but gets far more coverage and analysis in the French media and for good cause. Knowing who will be on the start line is critical when forming a view as to who may win the race and by what margin. Candidates this year have until 18:00 (local time) on 17th March to meet these and a number of other requirements (see Figure 7).

In previous presidential elections, the main potential candidates (based on their rankings in popular opinion polls and the size of the parties they represented) all managed to meet the main legal requirement, including the written support of at least 500 elected representatives and presentation to the Conseil Constitutionnel of a statement of his/her financial assets. The Conseil Constitutionnel publishes on its website twice a week (on Tuesdays and Fridays) an updated list of the sponsors’ names for each candidate and will do so until 17th March. It published today its latest update and a number of points stand out.

 

 

1) Seven candidates currently meet 500-sponsort threshold

To-date, François Fillon, Benoît Hamon, Emmanuel Macron, Nicolas Dupont-Aignan (France Arise Party), Nathalie Arthaud (Workers’ Struggle Party), Marine Le Pen and François Asselineau (Popular Republican Union party) officially have more than 500 sponsors (see Figure 8). Moreover, all seven candidates fulfil the condition that their sponsors should represent at least 30 French departments. Fillon and Hamon, which have respectively 2,111 and 1,317 sponsors, will on present count lose about 42 and 61 sponsors, respectively, as they breach the 50-sponsor-per-department threshold in two departments (see Figure 7). Clearly this is not an issue as they are both well above the 500 threshold.

 

2) Fillon well ahead on number of sponsors, despite investigation for misuse of public funds

It is notable that Fillon is well ahead in terms of confirmed sponsors, despite the likelihood that he will face, on 15th March, formal charges of misuse of parliamentary funds and despite diminished support from this own party. A number of his senior aides (including his spokesperson and foreign affairs adviser) have recently quit his campaign team and senior Republican Party members have distanced themselves from Fillon and pressured him to abandon his presidential bid.

His strong support amongst elected representatives is not totally surprising and is likely a factor in his decision to remain in the presidential race. After all, he convincingly won both the first and second round of the November Republican Party primaries and was until late-January second in the polls with around 25% support for the first round of the presidentials, only a couple of percentage points behind Le Pen. However, he likely faces an uphill battle over the next six weeks to convert sponsorship into electoral votes, with his popular support having failed to break through 20% since early February.

 

3) Alain Juppé has 288 sponsors despite not being a candidate for the French presidential elections

Juppé, who lost to Fillon in the second round of the November Republican Party primaries, currently has 288 sponsors despite having ruled himself out of the presidential election race. Moreover, in recent opinion polls Juppé had about 25% support and would make it to the second round with either Le Pen or Macron. However, regardless of whether Juppé crosses the 500-sponsor threshold, he will not be a candidate in the first round unless he confirms his candidacy in writing to the Conseil Constitutionnel by 17th March 2017. Fillon and Juppé have seven days to change their minds (see below for more details)

 

4) At least three minor candidates likely to make it to first round but of limited consequence

Baring a large number of their sponsors being invalidated, Nicolas Dupont-Aignan and François Asselineau, both euro sceptic right-wing candidates, and Nathalie Arthaud, a left-wing candidate, will make it to the first round. But this is likely of limited consequence. Dupont-Aignan and Arthaud, who respectively won only 1.8% and 0.6% of the votes in the first round of the 2012 presidential elections, are currently polling 3% and 1%, respectively, while Asselineau has typically polled 1% or less. Voter support for Dupont-Aignan and Asselineau would likely switch in large part to Fillon and Le Pen in the second round, which at the margin (and we are talking about a few percentage points at most) may work against Macron if he makes it to a second round run-off.

 

5) The Far-Left candidate is still short of 68 sponsors and may not make it to the first round

Jean-Luc Mélenchon only has 432 registered sponsors – 144 short of the 500 threshold (he meets the 30-department or more criteria). While he publicly claims to have the verbal support of more than 500 sponsors, he only has one week left to convert these verbal commitments into written forms of support. In the 2012 presidential elections, Mélenchon garnered about 1,100 sponsors – two and a half times the current number of sponsors who have officially registered their support for the Far-Left candidate.

Should he fail over the next seven days to cross the 500-sponsor threshold, this could have a non-negligible impact on opinion polls for the first round. Voter support for Mélenchon, which is hovering around 12%, could conceivably switch to other left-leaning candidates, namely Nathalie Arthaud and more importantly Hamon who is fourth in the polls for the first round with around 13-14% support. A significant shift of support to Hamon could see him vie for third in the polls, ahead of Fillon who is currently on 19-20% but this would still likely be insufficient for Hamon to threaten Macron and Le Pen who are both on 25-26%.

 

Does number of sponsors tell us anything about possible election results?

The electoral pre-requisite of obtaining at least 500 sponsors and bi-weekly publication of the sponsors’ names has attracted much criticism across the political spectrum. Candidates, in particular those of smaller political parties but also Le Pen, argue that the number of sponsors does not reflect the level of popular support. Figure 9 would tend to support this view. The correlation between the number of sponsors and votes won in the first round of the 2007 and 2012 presidential elections is not that strong, particularly for candidates with few sponsors. For example Marine Le Pen obtained only 550 or so sponsors in each of these two elections but won, respectively, 10.4% and 17.9% of the votes in the 2007 and 2012 elections.

 

 

The relationship also looks tenuous if we compare sponsors to date with opinion polls for the first round of the 2017 presidential elections (see Figure 10).

 

 

However, the correlation is somewhat stronger as the number of sponsors increases. In particular, Nicolas Sarkozy and François Hollande, who respectively won the 2007 and 2012 presidential elections, had respectively 3,885 sponsors[1] and about 4,750 sponsors[2]. If this statistical relationship holds this year, Le Pen’s chances of becoming president are slim. Conversely, the odds of Macron making it to the second round and winning the presidency would appear strong.

Moreover, this relationship between sponsors and election results would suggest that it is perhaps a little too early to complete discount the possibility of Fillon or Hamon making it to the second round, particularly if as discussed above Mélenchon fails to make it to the first round and a significant share of his voters switch allegiance to Hamon (a theme I had explored in EM currencies, Fed, French elections and UK reflation “lite”, 25 November 2016).

 

What if Fillon pulls out of the presidential race?

If Fillon pulls out of the race between now and the 17th March deadline for candidates to confirm their 500+ sponsors or before the first round, due to likely formal charges of public funds misappropriation, the ramifications are very unclear. France would be in unchartered territory as there is simply no precedent for a major candidate pulling out of the first round of a presidential election. But we can venture a few possible scenarios in the event of Fillon pulling out in the next seven days, which I summarise in Figure 11.

 

 

A potentially important variable in this scenario analysis is Clause 7 of the French Constitution, which states that[3]: If, in the seven days preceding the deadline for the registration of candidates’ sponsors, one of the persons who has publicly announced at least 30 days before this deadline his/her decision to be a candidates dies or finds himself/herself prevented, the Conseil Constitutionnel can decide to postpone the elections. If before the first round one of the candidates dies or finds himself/herself prevented, the Conseil Constitutionnel will postpone the elections”.

There are two key words. The first one is “prevented” (or “empêchée in the original French text) but no definition is provided for a person being “prevented” from running and therefore there is much scope for legal interpretation. The second is “can decide to postpone” versus “will postpone” (my emphasis). This suggests that if Fillon pulled out by 17th March and the Conseil Constitutionnel ruled that Fillon had been prevented from running, it would have the option but not the obligation of delaying the presidential elections. But if Fillon pulled out between 18th March and 23rd April (the date of the first round) and the Conseil Constitutionnel ruled that Fillon had been prevented from running, it would automatically postpone the elections.

The Conseil Constitutionnel has so far not commented on these possible scenarios and I strongly believe that it will want to avoid setting the precedent of delaying the presidential elections (and potentially having to also push back the June legislative elections). Specifically, the closer we get to the first round, the less likely it is that the Conseil Constitutionnel would take the far-reaching decision of pushing back the elections, in my view.

 

Olivier Desbarres

Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He has over 15 years’ experience with two of the world’s largest investment banks as an emerging markets economist, rates and currency strategist.


[1]  Before subtracting sponsors which breached the 50-sponsor-per-department limit.

[2]  The Constitutionnel Court did not publish official sponsorship figures in 2012 but the Socialist Party claimed that Hollande had the confirmed support of 4,500-5,000 sponsors.

[3] The official French version states that:”Si, dans les sept jours précédant la date limite du dépôt des présentations de candidatures, une des personnes ayant, moins de trente jours avant cette date, annoncé publiquement sa décision d’être candidate décède ou se trouve empêchée, le Conseil constitutionnel peut décider de reporter l’élection. Si, avant le premier tour, un des candidats décède ou se trouve empêché, le Conseil constitutionnel prononce le report de l’élection”.

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