Daily Comment (April 21, 2017)

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] On Sunday, the French go to the polls.  The most recent polling shows Macron as the most popular candidate at 24.0%, with Le Pen second at 21.5%, Fillon at 20.0% and Mélenchon at 19.5%.  Polls open at 8:00 am (CEST), which is 2:00 am EDT, and close at 7:00 pm, or 1:00 pm EDT.  Exit polls are technically not legal but usually information begins to emerge from other European nations throughout the day.  Final results could take a few days so we may not know the outcome on Monday.  The president needs a majority to win and if no candidate gets more than 50% then a runoff election will be held on May 7.

Until recently, it looked like a two-person race, with Le Pen and Macron likely to face each other in a runoff.  However, polls have tightened considerably and it is possible that either Fillon or Mélenchon could make it to the second round.  For the financial markets, the best outcome would be Fillon, who is center-right, facing Macron, a centrist.  Neither man has called for a withdrawal from the Eurozone or the EU.  The worst outcome would be Le Pen and Mélenchon in a runoff.  Both are populists, with the former coming from the right and the latter from the left.  Both have an anti-euro and anti-EU policy platform.  The most likely outcome is still Le Pen and Macron, but turnout will be key.  Polling suggests that Macron’s support is shallow and a low turnout will tend to support the more radical candidates and lead to a Le Pen/Mélenchon runoff.   It should also be noted that undecided voters make up about one-third of the electorate; to be undecided at this stage may signal a low turnout.

What has been lost in the focus on the presidency is that legislative elections are scheduled for June 11.  Both the National Assembly (lower house) and Senate (upper house) hold elections on this day.  The voting is rather complicated and usually leads to a runoff that will be held on June 18.  The bottom line is that the president’s powers are affected by legislative support.  If the president’s party fails to gain a majority in the Assembly, the president’s ability to affect policy is severely limited.  The French system is “semi-presidential” in that the domestic agenda is run by the prime minister, while foreign and defense policy lies with the president.  The president appoints the PM but the Assembly has the ability to force out any PM they don’t like.  Thus, without a secure majority in the National Assembly, the president is essentially forced to choose a PM that may be in the opposition.

Only Fillon comes from a large national party.  The other three leading candidates represent small parties, with Macron having recently created his.  Accordingly, if one of these three candidate wins, it is highly likely they will be forced to select a PM that doesn’t really represent their policy positions.

Even if the worst outcome occurs, in reality, the ability of the new president to force through a radical agenda will be limited.  At present, polling is limited but it appears that no party will gain a majority in the Assembly, meaning that the president will likely need to govern with a coalition and appoint a PM that is amenable to the newly elected members.  The most likely outcome is gridlock.  At the same time, the election of Le Pen or Mélenchon would upset the financial markets because it would show rising discontent with the EU and Eurozone and provide further evidence of rising populism.

From the beginning of the Trump administration, we have postulated that the president would need to vacillate between two poles, the establishment and the right-wing populists.  And, for all the fury and noise, that is what he has done so far.  On financial regulation and reducing government oversight, Trump is executing a mostly establishment GOP position of smaller government.  At the same time, on immigration and trade, the president is clearly populist.  Border walls and enhanced deportations show his position on immigration.  Yesterday, we saw more evidence on trade as the administration prepared actions to protect steel.  We expect this pattern to continue.

As we approach the 100-day mark of Trump’s presidency, there are reports of a flurry of activity coming from the White House.  These include a new attempt to overturn the ACA, money for a border wall and more executive orders on regulation.  The problem is that we are also facing a funding deadline which requires legislation in order to keep the government functioning.  These initiatives from the White House are reportedly interfering with efforts to keep the government running.  Although we don’t expect a government shutdown, we do expect a “Twitter storm” from those saying the administration got a lot accomplished in its first 100 days and from those who suggest it was a bust.  In reality, the 100-day mark is not all that important but the charges and countercharges would be a distraction in the coming days.

Yesterday, equities got a boost from SOT Mnuchin’s promise that the administration will have tax reform completed by year’s end.  Although we doubt there will be any major reforms by then, we would not be surprised to see “reform lite,” which would likely include a modest cut to rates (5% max) and a repatriation deal.  Even that could lead to a widening of the deficit.  To counter this problem, it appears the administration will rely on faster future growth to fund the tax cuts, a process formally called “dynamic scoring.”[1]  If the growth fails to materialize, the deficit would widen.

Finally, tensions on the Korean peninsula remain high as North Korea appears poised for a nuclear test.  There are unconfirmed reports that the Chinese and Russian militaries are on alert.  All we are seeing is rhetoric and some degree of preparation, but there is always the potential for a mistake.  So far, the financial markets have ignored this issue, mostly because there is always some degree of tension in this part of the world.  Still, as we have noted before, we have a young leader in North Korea who appears insecure in his position and thus may be prone to rash actions.

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[1] http://www.reuters.com/article/us-usa-tax-trump-idUSKBN17M2PQ