Victory for Macron, but challenges ahead

Emmanuel Macron won the French presidential election in an even bigger landslide than most polls and analysts had expected, with 66% of the vote. Those in favor of globalization, the European Union (EU), and the liberal order in Europe breathed a collective sigh of relief with the result.

While yet another European country avoided electing a populist party and potentially creating severe market dislocations, it's worth noting that there are still many challenges ahead for France and for Europe. President-Elect Macron is likely to face some difficulties in governing France, and antiestablishment parties are here to stay in Europe, whatever the result in the Dutch, French, or German elections this year.

Macron has pulled off an incredible feat, creating a political party, En Marche!, and winning the presidential election in less than a year. But the president in France can't operate by executive decree—to pass legislation for the difficult reforms that France needs, particularly in the labor market, there must be support in the National Assembly (the French Parliament's lower house) as well. There will be elections for the 577 seats in the National Assembly on June 11and 18; while betting site Betfair has En Marche! leading in the National Assembly elections,¹ it seems unlikely the party can win an absolute majority given that it is so new.

The best President-Elect Macron can probably expect is that his party wins the largest share of seats among all the parties in the National Assembly. He would then have to find partners to legislate and implement his business-friendly economic reforms, some of which threaten the orthodoxies of the traditional centrist parties (reducing the size of the public sector, for example). If the traditional centrist parties in the National Assembly don't want to support Macron's policies, the president will have difficulty pushing his agenda through.

President-Elect Macron will also need to unify a divided country that has been stuck in national economic malaise for years. Antiglobalization, anti-European candidates won roughly 40% of the vote in the first round of the French presidential election, between MarineLe Pen, far-left candidate Jean-Luc Melenchon, and a handful of minor extreme candidates.²

Many analysts have taken the progression of Brexit in the United Kingdom last year, the defeat of Dutch Nationalist Geert Wilders in the Netherlands in March, the defeat of Ms. Le Pen in France, and the likely defeat of the populist Alternative for Germany (AfD) party in the German elections in September to mean that populism is waning in Europe. Some have gone even further, suggesting that populism is a unique Anglo-Saxon phenomenon-with Brexit in the United Kingdom and President Trump in the United States—and that the Continent may be immune.

If only it were that simple.

First, national elections in Europe tend to be about national issues. Even European elections in Europe tend to be about national issues. There's little chance that the defeat of populists in one European country has much to do with the defeat of populists in another, and so stringing these elections together and giving them a causal relationship doesn't really work.

Second, while Ms. Le Pen didn't win, her party's support—at roughly 35%—was the highest in the party's history and nearly double what the Front National received the last time it made it to the second round.³ As I have mentioned, populist parties are often more effective in opposition than in government. Even if the Front National doesn't win a significant number of seats in the upcoming National Assembly elections, Ms. Le Pen will likely manage to shape and direct political discourse from the sidelines.

The fragmentation of Europe's political spectrum since the global financial crisis indicates that voters in Europe do not identify with the traditional center-left and center-right parties in the same way they used to. Rather than focusing on Christian values (center right) or organized labor (center left), voters are increasingly concerned about national/cultural identity and globalization. The center right and center left are very unlikely to collectively win over 80% support and dominate politics, as once was the case. As one of the world's experts on populism, Cas Mudde, commented on Twitter, the French presidential election is another step in the slow and steady electoral rise and political normalization of the populist radical right. If President-Elect Macron is unable to push through his agenda in the National Assembly, who's to say that Ms. Le Pen won't do well in the 2022 elections?

We may not have to wait until 2022 to see a populist movement enter government in Western Europe. With the French elections behind us, investors should turn their attention to upcoming Italian elections, to be held by March next year. There, the Five Star Movement (M5S) has consistently come out on top in opinion polls. While former Prime Minister Matteo Renzi has won a new mandate to lead his party (the center-left Democratic Party (PD)) into the next elections, he'll likely find the M5S a real competitor.

The worst-case scenario for Italy economically is that the M5S wins the election, forms a coalition, holds a referendum on Italy's euro membership, and Italians vote to leave the European project. There are many hurdles to this happening—most notably, it's unclear which other parties might agree to rule with the M5S in a coalition. To have a governing majority, the M5S may have to partner with the PD, and it seems unlikely that the PD would have any interest in being a junior coalition partner. But Italy is the only country in which support for the EU actually fell after the Brexit vote last June (it rose in every other EU country). The EU and the euro have long been much less popular in Italy than in France; this nightmare scenario isn't an impossible one, and it would certainly be a high-impact event.

Another realistic scenario for Italy is that no party surpasses the 40% threshold in the lower house necessary to win bonus seats and the country is stuck with a hung Parliament. In this case, the most likely potential governing coalitions would be unstable. This would be more of a slow-burning issue, with Italy unable to implement the product or labor market reforms necessary for sustainable growth going forward. Italy would potentially add political uncertainty to a backdrop of sluggish economic growth, banking instability (the government has yet to announce its solution for MPS and nonperforming loans remain elevated), and higher borrowing costs (we expect the European Central Bank to begin tapering its quantitative easing program—from which Italy has benefited significantly—next year).

Macron pulled off an incredible feat, creating a political movement and winning the presidential election all in less than a year, but just because Ms. Le Pen did not win doesn't mean that she completely lost. The Front National will continue to influence political discourse in France from opposition and may be back as a real challenger in future elections. Even though the French elections were a political victory for those in favor of globalization and the liberal order, it's too simplistic to say that populism has peaked in Europe and is now waning. The days when voters stuck with their traditional center-right and center-left parties in Europe are gone, and that's unlikely to be reversed anytime soon. Nowhere will this be more obvious than in the upcoming Italian elections, which could range from being moderately bad—a hung Parliament—to very bad—a euro exit—for the Italian economy, with implications for Italian and European asset classes.

1 Betfair.com, 2017.

2 French Ministry of the Interior, 2017.

3 French Ministry of the Interior, 2017.