Macron Has Gambled… And Lost

By Elwin de Groot, Head of Macro Strategy at Rabobank

We still have one more day to go in the European session before the weekend, but the week in review is already showing to be one of quick decisions, where the bond market was ‘saved’ by the US inflation data and where Macron may have asked for a Papal blessing. But whether that turns out to be sufficient remains to be seen.

Macron has gambled… and lost? According to the latest polls, only 40% of Macron’s MPs would gather enough support to even qualify for a second round of run-off votes. In a surprise move, the French president announced elections last Sunday. Macron may have acted quickly after the results of the European Parliament elections in the hope that he could ride a fear-inspired wave of solidarity that could stop Marine Le Pen’s National Rally in its tracks. However, that move could backfire pretty badly.

According to an Elabe/Les Echos survey, Macron’s approval rating fell to its lowest level in 5.5 years. Macron has made an appeal on voters and the more moderate political parties on both the left and the right to not succumb to the “fever of the extremes”, but it remains to be seen whether his strategy will succeed.

Left-wing parties have equally quickly decided to unite, with a joint programme and a joint list of candidates for the Greens, Socialists, Communists and France Unbowed. The Socialist Party issued a statement yesterday saying that “There was an expectation of union expressed”; but obviously not the unity that Macron was looking for. This quick decision may just undercut Macron’s. It means that the president’s centrist MPs could be squeezed out of parliament by their competition from the left and right side of the field.

Fever of the centre? Finance Minister Le Maire predicted earlier this week that France would face a debt crisis if the National Rally should come to power. This suggests that Macron’s strategy is first and foremost one of sowing fear, and that things have to get worse before they get better. But there seems very little time for that second leg of Macron’s strategy: to get better. Sometimes quick decisions are not always the best decisions.

Macron’s European peers seemed bewildered at the G7 meeting in Italy. According to the news wires Macron only met with Canada’s Trudeau, as well as the leaders of Algeria, India, and Brazil. And with the Pope. You’d wonder if he asked for a little prayer or perhaps a Papal blessing.

The political uncertainty in France seems to have turned into a classic risk-off sentiment. The search for safe havens were one of the reasons that the yield on 10y Bunds declined 6bp yesterday. Meanwhile, the spread between 10y French and German bond yields has widened to the highest level since April 2017. Alongside, the euro dropped below 1.073 and European equities were in the red (Eurostoxx 50 -2%). Prayer or blessing, it definitely did not reassure investors.

But safe-haven assets in both the US and Germany also found some support in the better-than-expected inflation data. Both the headline and core US PPI inflation were significantly lower than expected, strengthening the view that inflationary pressures have finally started to ease. The yield on 2y Treasury notes of fell the lowest level since 4 April, despite the Fed adjusting its dot-plot to reflect one instead of three rate cuts for this year and despite Powell’s reluctance to embrace the most recent CPI report.

More quick decisions. In any case, the prospect of further backlashes after the French elections, political uncertainty in Europe, and a possible Trump re-election are perhaps forcing more quick decisions.

G7 leaders agree to provide a $50 billion loan to Ukraine. The agreement was reached on the first day of the G7 meeting in Italy. The G7 leaders quickly agreed to the loan that is backed by frozen Russian assets. The proceeds on these assets (estimated at some $260 billion in Europe) will be used to pay off an upfront loan to Ukraine. As AP news notes, member states may treat this differently according to national preference/regulations. But the lenders do of course bear the risk that those proceeds would stop if a peace agreement is reached and the Russian assets are unfrozen in the future.

The EU announced additional tariffs on Chinese EVs. It’s another quick decision after the investigation into unfair state subsidies was completed, and it will enter into force with little delay. The EU announced additional tariffs on Chinese EVs ranging from 17 to 38% this week, which will take effect on July 4.

The Germans seem to be hopeful that there is still wiggling room to negotiate with China before the tariff is hiked, but France’s Le Maire applauded the European Commission’s decision to increase import duties on Chinese cars: “It’s a first decision that I hope will be followed by others, notably on solar panels, and on other Chinese over-capacities.” However, as my colleague quipped yesterday, imposing tariffs on Chinese solar panels is only a decade too late. Still, it shows that the French government is ready to “re-establish the balance of power with China.”

That European industry is still struggling was underscored by the data: Eurozone industry output fell 0.1% in April. Although it wasn’t a big decline it was still weaker than expected (+0.2% m/m). Together with downward revisions in earlier data the annual growth rate fell to -3% y/y. That is still a firm ‘recession’ indication and underscores that the economic recovery in the Eurozone is still a wobbly one, weighed down by structural issues in the manufacturing/export sector and weakness of demand from China (China’s imports from Germany, for example, were down 14% y/y in May after 0% in April).

The Bank of Japan needs a little more time for an exit strategy. The overnight call rate was left unchanged at 0.0% to 0.1%. And policymakers voted to continue their current asset purchases until the July meeting, despite Governor Ueda’s earlier indications that a reduction in the bond buying programmes may be due. The central bank will come with a plan for reducing its bond purchases over the coming 1 to 2 years at their next meeting.

In his press conference, Ueda stated that the reduction in bond purchases will be substantial. But not all decisions can be quick. The central bank will be mindful of the potential market disruptions if policymakers move too hastily. The Bank will not want to inject undue volatility into the JGB market given the potential impact on the balance sheets of Japan’s large insurers and in view of its own huge holdings of domestic bonds. Yet, moving slowly will continue to weigh on the currency. The market had anticipated some adjustments today, so the postponing the decision to next month caused some further weakness in JPY. USD/JPY rose above 158.