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Macron’s Reforms: En Marche or En Grève?

Published June 30, 2017

Esther Baroudy, Global Equities Portfolio Manager, Active Fundamental Equity
Bill Street, Head of Investments, EMEA

Against all the odds, outsider Emmanuel Macron swept to power in May, becoming France’s youngest president since Napoleon and overturning the established order of French politics. Now the former banker has unveiled the first in a series of bills aimed at modernizing the economy and tackling structurally high unemployment. But can he get the legislation passed? Or will the same industrial action (grèves) that plagued his predecessors bring his La République En Marche! movement to a halt?

Markets Delighted With Macron… For Now

So far, markets have responded positively to Macron. Following his first round election win against Front National’s Marine Le Pen, the CAC 40 jumped 4%, while the spread between the yields on French government bonds (OAT) and German Bunds fell 20 basis points. And the euro surged to a five-month high as the threat of Le Pen’s anti-European Union populism receded.

However, in the wake of Brexit and Le Pen’s high-profile campaign, we believe the pro-EU Macron needs to demonstrate that being inside the eurozone can deliver greater prosperity for everyone in France. If the European project is to survive, it needs both sides of the pivotal Franco-German axis to flourish.

Crucial Labor Reform Needed

First on Macron’s to-do list is labor market reform. For years, the French economy has been weighed down by high employment costs. French companies have to pay much bigger social security contributions as a proportion of salaries than firms in other countries (see Figure 1). The result has been persistently high unemployment, especially among the young, and the issue has taken on huge political and social significance.

On June 28, Macron’s government introduced a labor reform bill designed to address this problem. Fast-tracked through the legislative process and to be voted on during an extraordinary Parliamentary session on July 24–28 — the aim is to put a series of decrees in place by September 20 and introduce laws to ratify the decrees this autumn. The planned reforms are extensive and potentially controversial:

  • Companies would have greater discretion to negotiate contracts with employees, especially with regard to pay and working hours.
  • Union organization within firms would be simplified and allow for a better choice of representation in the workplace.
  • Employment tribunals would have their power to make redundancy awards curtailed — a measure that prompted street riots before being withdrawn by the previous administration.


Dramatic Potential of Reforms

If Macron can push through these reforms, the impact could be dramatic for French companies — in terms of greater capital investment and increased profitability — and for French and European stock markets. At present, however, we see that as a big “if.”

Although La République En Marche! won a convincing majority in the Parliamentary elections, turnout was low, with almost 60% of voters abstaining. This gives the government less legitimacy for its mandate than Macron might wish. And while meetings between the government and most of the unions have so far been cordial, vested interests are entrenched and could yet provoke a backlash. The militant Confédération Générale du Travail (CGT) union’s response to the bill’s presentation to the Council of Ministers on June 28 was to call for a day of action in September. It could be a long, hot summer for Macron if more unions call for strikes and take to the streets in protest.

In an attempt to carry the public with him, Macron is convening a special Congrès at Versailles on July 3 at which he will address the Senate and the National Assembly. A Congrès is only held in exceptional circumstances, so he will need to use the occasion to convince the country to stick with him and support the detailed policy plans to be announced on July 4.

A broad recovery in Europe coupled with economic reforms are likely to boost France’s GDP, but initially, we would expect overall job numbers to decline as companies capitalize on greater flexibility to improve their cost base. While this may be partially offset by greater business investment at this point in the cycle, it may take time for unemployment to fall significantly — a view that runs contrary to current consensus estimates that unemployment will fall steadily over the next three years (see Figure 2).

Budget and Deficit Measures Affect Bond Markets

Nonetheless, Macron’s impressive rise to the presidency gives him a window of opportunity for dealing with France’s unsustainably high government spending rate —at 56.5% of GDP in 2016 according to the Organization for Economic Co-operation and Development (OECD) — and tackle its budget deficit, which has been above the Maastricht deficit target of 3.0% since 2008. By comparison, Germany is currently running a small surplus.

As we see it, the stakes are high. The Cour des Comptes (which audits state budgets) believes that France will breach the 3.0% deficit target this year, following “insincerities” in budget statements given by Macron’s predecessor, François Hollande. Macron’s government has vowed to meet the target through spending restraint rather than further tax increases.

With little room to manoeuvre on fiscal policy, improving the economy’s ability to produce is crucial to offsetting any pain from government spending cuts. In the run-up to the election, French OATs traded at a significant spread over German Bunds amid fears of an extremist win and a potential French exit from the EU. After Macron’s win, the spread has narrowed sharply, making it cheaper for the French government to borrow (see Figure 3).

However, if Macron struggles to get the budget under control or reduce the deficit while monetary policy remains loose and the economic backdrop favorable, OAT–Bund spreads could return to pre-election levels, damaging his political capital and the prospects for the European project.

 

Definitions

CAC 40 (Cotation Assistée en Continu) is a benchmark French stock market index representing a capitalization-weighted measure of the 40 most significant values among the 100 highest market cap companies on the Euronext Paris.

Maastricht Treaty signed in 1992 set the terms for the integration of Europe, establishing the criteria for member states to enter the European Economic and Monetary Union (EMU) and adopt the euro as their currency.

 

Disclosures

The views expressed in this material are the views of Esther Baroudy and Bill Street through the period ended 6/30/2017 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

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