Mark Lister , 24 April 2017

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Results are coming in for the first round of voting in the French election, and at first glance it looks like a market friendly outcome. Former banker and Economy Minister Emmanuel Macron looks to be out in front, closely followed by anti-euro candidate Marine Le Pen. Expect risk assets to be well-supported in the aftermath, and short-term political risk in Europe to fade slightly.

What has happened over the past 24 hours in France?
Voting in the 2017 French election closed Monday morning at 6:00am NZ time. Soon after this, exit polls clearly pointed to Macron and Le Pen emerging as the two frontrunners. With centre-right candidate Macron looking to have won 24% of the vote and Le Pen from the National Front close behind on 22%, these two look set to move through to the second round run-off on May 7. The other two key candidates, François Fillon and JeanLuc Mélenchon, have reportedly won just below 20% each, while Benoît Hamon (in fifth place) trails the other four with less than 10%. Results could change slightly as votes are counted and officially released, although it is unlikely to alter the two top contenders.

What comes next?
The second round will be held on May 7, in two weeks’ time. Assuming the initial exit polls are accurate, it will be between Macron and Le Pen, with Macron the favourite. With Macron a mainstream candidate, and Le Pen more of a potential wildcard, it is likely Macron will attract many of the votes that went to the other mainstream candidates (namely Fillon and Hamon) in the first round.

However, this is certainly not a given, even though Macron has emerged in first place this time around. In 1974, 1981 and 1995, the second placed candidate has gone on to become President. In 2002, Le Pen’s father went through to the second round before losing to Jacques Chirac (who won in a landslide with 82% of the vote). Both Hamon and Fillon quickly came out and backed Macron, urging their supporters to cast their votes in his favour. This certainly puts Macron at an advantage, even though Le Pen will no doubt find favour with many of the Mélenchon supporters.

What can we expect from markets in the immediate aftermath?
This outcome was the base case for many, including ourselves. Markets will breathe a collective sigh of relief, as will the French pollsters (who have proved more accurate on this occasion than those in the UK or the United States were last year). Le Pen was always highly likely to be one of the top two, but the nightmare scenario was one where the two frontrunners were Le Pen and Mélenchon.

The strong showing from Macron suggests that we will see stable leadership in France, no referendum on European Union (EU) membership, and a market friendly outcome over the short-term. Although there is a chance of an unpredictable outcome in two weeks’ time, this is looking unlikely.

Expect equities (particularly those in Europe) to experience a modest relief rally over the short-term, the euro to strengthen, and safe haven assets (like gold) to give back some ground.

In this part of the world, equities are likely to benefit from the more positive global sentiment, although to a much lesser degree.

Why is the French election such a big deal anyway?
Among other things, Marine Le Pen wants a Brexit-style referendum on France’s membership of the European Union (EU). This has been the key risk regarding the French election.

France is the second largest economy in the Eurozone, behind Germany. Unlike the UK, it is part of the Eurozone monetary union, meaning it shares the euro currency with a number of other countries including Germany, Spain and Italy.

While the UK was part of the 28-member EU, it always retained its own currency (the pound sterling) rather than joining the smaller, more intertwined group of EU countries that chose to adopt the euro.

Because of this, a “Frexit” would be a much more difficult and disruptive exercise, that would result in significantly more market volatility. In all likelihood, it would trigger a breakup of the Eurozone.

Europe is an important market for New Zealand
The EU is New Zealand’s third-largest trading partner, representing 11.9% of goods and services exports in 2016, behind Australia (18.3%) and China (17.5%). The US is a close fourth, taking 11.5% of our total exports. Two-way trade between us and the EU was valued at over $20bn last year.

However, these EU figures include the UK (which for the time being is still part of the EU), which represents about a third of our exports to the EU. Outside of the UK, our biggest individual country trading partners in the EU are Germany (2.1% of total exports last year), France (1.0%) and Italy (0.6%).

While the EU and the UK are important markets for us, the biggest four individual countries we export to are Australia, China, the US and Japan. These four combined represent a little more than half of total goods and services exports.

Our biggest goods exports to the EU are meat, fruit and wine, while it is an important tourism market as well. In the last 12 months 15.1% of visitor arrivals came from Europe, which was a 12% increase on the previous year. Again, the UK is part of these numbers, and is the biggest contributor, representing 6.3% of total visitor arrivals and our fourth biggest visitor market (behind Australia, China and the US).

However, Germany is not far behind the UK, in fifth place overall representing 2.9% of arrivals. Visitor numbers from Germany increased 14.1% compared to the previous year, more than double the rate of growth from the UK and well ahead of the average. France is a smaller visitor market, representing 1.1% of arrivals in the last year.

Does this mean Europe is out of the woods, in terms of political risk?
Unfortunately, it does not. The French election was the key short-term risk, although European politics will remain a focal point over the rest of this year, and into 2018. There is a string of elections still to come on the calendar and while some are more important than others, the political surprises of the past year will keep investors anxious.

Germany holds its election on September 24, a day after the election here in New Zealand. Italy is also scheduled to hold elections no later than May 2018, although these could come earlier.

Overall, pro-euro sentiment in the 19 member states that share the common currency is at a healthy 74%. Sentiment is also relatively strong in individual countries.Germany remains the most positive regarding the euro with 81% in favour, while Italy looks to be the country least sympathetic to the monetary union at just 53% in favour. France is currently sitting at 68%, in between the two. On this basis, it could well be the Italian election that has the most potential to disrupt markets.