French elections: Comments from Anthony Doyle (M&G Investments)

We have witnessed some big moves in financial markets in the early hours of trading today following the confirmation that Emmanuel Macron will face Marine Le Pen in the second round of the French Presidential election. European corporate bond spreads were tighter on the news, and the euro was up by over 1% versus the U.S. dollar.

The relief rally was spurred on by the latest opinion polls suggesting a comfortable lead for Macron, indicating that he will be the next President of France. The market is now pricing in a “President Macron” scenario with a fairly high degree of confidence. Of course, a Le Pen victory should not be entirely discounted, and the markets may continue to exhibit volatility dependent upon the latest polling results.

Looking forward, Europe will continue to face a busy political calendar with a UK general election in June, an election in Germany in September and an election in Italy before April 2018. Consequently, the focus will now shift to the improving Eurozone economy and the prospect of the European Central Bank beginning to withdrawal monetary policy stimulus. European government bond yields will likely come under pressure in the months ahead, as will European investment grade corporate bonds that have benefited from the ECB’s bond buying programme. The Corporate Sector Purchase Programme has been a strong support for short-dated A-rated credit, and to peripheral European credits in particular. Despite this upward pressure, we do not expect large increase in the bond yields of core European government bonds but they should rise to some extent due to a higher inflation premium. For this reason, we are underweight European duration. Looking at credit markets, with global and European economic growth improving over the course of the next 12-18 months, default rates are expected to remain low, suggesting a favourable environment for European investment grade and high yield corporate bonds.

With the European economy likely to continue to improve and core inflation picking up over the course of 2017, we expect the tapering of asset purchases will be announced by the ECB in Q3, with a deposit rate hike in early 2018 and a potential refinancing rate hike to come in late 2018. European financial conditions will likely remain at an extremely accommodative level, with the ECB withdrawing stimulus at a very gradual pace given the high levels of public and private debt that exist within the euro area.

Anthony Doyle – Investment Director, team Retail Fixed Interest – M&G Investments