Market review: What’s next for France and U.S. health care?

We saw a mélange of events unfold and data points released in the past week. The U.S. House narrowly passed the American Health Care Act (AHCA), the U.S. jobs report for April beat expectations and centrist candidate Emmanuel Macron won the French presidential election.

But while these events answered some key questions that were weighing on markets, there are many more lingering issues yet to be resolved.

Health care focus delays progress on tax reform and infrastructure

The House’s passage of the AHCA has significant meaning for investors. The key takeaway is that President Donald Trump has prioritized health care reform over other legislative agenda items that could be very stimulative for the economy; in other words, tax cuts get pushed to the back burner, and infrastructure gets pushed even further back on the agenda.

Attention would then turn to the budget for 2018. Both the House and Senate Budget Committee chairpersons said they won’t release the fiscal 2018 budget until after the health care legislation is passed. That should push tax reform to the fall of 2017, with passage of a tax bill likely in the first quarter of 2018 at the earliest. This means that, in a best-case scenario, an infrastructure plan is likely to be passed later in 2018.

This is unfortunate as tax reform and infrastructure both have the potential to positively impact the economy, while debate and negotiation over health care has the potential to deplete political capital for the Trump administration and polarize different factions of Congress. In short, a long delay may adversely impact the stock market, given that stocks appear priced for legislative near-perfection.

Strong jobs report increases odds of June rate hike

Last week also saw the release of the U.S. Department of Labor’s April Employment Situation Report, which showed a significant improvement over the March jobs report. Headline unemployment (called U3) declined to 4.4%, a level not seen in the last decade. A broader definition of unemployment (called U-6), which includes people who are marginally attached to the workforce and those unable to find full-time employment for economic reasons, also experienced significant improvement.

This strong jobs report has increased the likelihood that the U.S. Federal Reserve (Fed) will raise rates when it meets in June. Last week, the CME Fed Watch Tool, which is based on pricing data for fed funds futures, predicted a 67.5% probability of a June hike. However, since the jobs report was released, that probability has increased to 83.1%. While a June rate hike is not a done deal yet – we’ll certainly get more insight into the Fed’s current thinking when the Federal Open Market Committee minutes are released later in May – it is my base-case scenario. In my view, stocks will likely produce a mildly positive reaction to a rate hike in June, especially if it is well telegraphed, viewing it as a vote of confidence in the U.S. economy.

Plenty of questions remain for France’s new president

Finally, Emmanuel Macron was able to beat his anti-EU challenger, Marine Le Pen, in the runoff presidential election in France. The day after the election, capital markets gave a collective sigh of relief given the vulnerability of the European Union in the event of a Le Pen victory. In her concession speech, Ms. Le Pen acknowledged that French voters chose “continuity” and that will likely be the theme for France going forward.

However, the reality is that, along with the continuity of France remaining in the EU, there will be a significant level of uncertainty. Keep in mind that the political party President-elect Macron represents is less than one year old. The new president must build a coalition in parliament that supports his legislative agenda, which means he will need to focus on winning enough votes in next month’s parliamentary elections. The good news is that his platform is pro-business, which should be largely stimulative for economic growth; among his areas of focus are labor reforms and reforms for the EU. And France needs some stimulus, given that growth in the first quarter of 2017 was just 0.3%.¹

The stakes are high: if Mr. Macron is unable to achieve his agenda, he will have a powerful opponent on the sidelines to document his failures and use them against him when they meet for a rematch and, if the economy fails to gain traction, there will be more disenfranchised voters willing to vote against “continuity.”

Takeaways for investors

In short, much of what unfolded this week was either expected or welcome – or both. So it’s no surprise that both the S&P 500 Index and the EURO STOXX 50 Index finished the week higher, and the VIX, which measures volatility, fell. However, we can’t forget that just a few weeks ago, the VIX was at a much higher level – and it can easily rise again as geopolitical risks abound.