The Economist Riff of the Week: France

"To source my stories, I read a tremendous number of books and papers, I subscribe to research services, and I read The Economist religiously"

Jim Leitner, Founder of Falcon Management

In Stephen Drobny’s book, “Inside the House of Money”, Jim goes as far as to say that he could trade pretty well if his only news and research source was The Economist. I’m not here to deify the magazine--I would tend to concur with those that think their agenda has gotten a little tiresome.

That being said, I would agree that if you are going to read one thing all week, The Economist should be it. As a public service this is the first edition of a new MM feature, "The Economist Riff of the Week.”  

This week we start in France:

The story notes how Macron’s “En Marche!” movement has taken the lead in polls for parliamentary elections, and now looks likely to win a strong majority. The first round was yesterday, and Macron did indeed win a huge victory, one that pollsters project will win him between 415 and 455 of the 577 seats in parliament.

Macron has been given the mandate to implement his agenda. From a macro perspective, the three most important planks of his platform are fiscal policy, labor reform, and pension reform.  Macron has promised to put “France back to work”, increase productivity, reform what was once thought unreformable, and fix France’s broken growth model. But what does he really stand for?

Fiscal policy--Here are some quotes from Macron’s economic platform:

“We will therefore reduce the share of expenditure in national wealth to 52% in 2022: the difference between the level of expenditure in France and the average level in the euro area (48.5%) will thus be reduced by half;”

Alright--Macron wants to reduce government spending--to a level which is still 3.5%/GDP above the Euro area average . At least he’s pointed in the right direction. How’s he going to do it?

“Public spending will be reduced by EUR 60 billion per year by the end of the five-year period.

This is done via three channels:

1. The social sphere: 25 billion euros in savings. With the reduction in unemployment (aiming at a rate of 7%), unemployment insurance expenses are automatically reduced. With health insurance spending contained at 2.3% per year thanks to better prevention and better coverage of care, a saving of 10 billion euros is foreseen.
2. The State: 25 billion euros of economy, modernizing the civil service and aiming for a realistic and differentiated reduction of the posts in the public civil service.”

Both about 1%/GDP. #2 sounds pretty vague and squishy. And in #1, Macron is claiming 25bn euros in savings by reducing unemployment to 7%. Let’s look at his assumptions:

He is forecasting 1.7-1.8% GDP growth for 2018-2022. Here’s how France has grown for the prior five years:

GDP growth hasn’t cracked 1.5% since 2011--so optimistic at best. Where will this magical growth come from? Macron believes labor and pension reforms will reduce labor expenses enough to make the economy more competitive, especially with their Teutonic neighbors to the east. But Macron’s labor policies look like tinkering to me--hardly the tough medicine necessary to change a chart like this:

Same story on pension reform--Macron is essentially suggesting to streamline the system rather than change it radically. Not a bad idea, but hardly a radical one.

Macron claims he is “neither right nor left”. Indeed, he is Tony Blair, not Maggie Thatcher. But France needs a Thatcher.

Accordingly I’m not bulled up on France here--but given the recent volatility and the big victory yesterday, it is worth it to roll through some charts.

This is 10y and 30y OATs vs. Bunds. If you really buy into the “New France” story, there is good value for more tightening here. I could see trying to buy the 10y oat vs. 10y bund at a 35bps spread looking for a move to the mid 20s, but I’m not crazy about it.

There’s some directionality with outright Bund rates--but in the recent range the spread has traded tighter from current levels, and the future outlook for France is certainly better than it was in late 2014-early 2015 when there was a ton of Asian demand for OATs.

Another clever idea would be a 10s30s OAT flattener--this is trading at the top of the range, along with Bunds, which is interesting given the huge flattening in USTs over the past month or so. If Macron delivers on reforms, 10s30s will flatten, and you are getting a nice entry point here.

French bonds also look at little cheap vs. Belgium.

No home runs here--but maybe a few clean singles good for 8-10bps. Chime in if there are any great insights out there--or let me know what caught your eye in the Economist this week.

Shawn
TeamMacroMan@gmail.com

@EMInflationista