French election preview
The French public goes to the polls on Sunday, April 23rd in one of the most unpredictable and closely-fought presidential elections in recent memory. It’s also one of the most important for France in decades with voters apparently split between extremes of left and right. Success for the National Front’s Marine Le Pen would present a major risk to European markets but she is no longer the only candidate who could disrupt markets as the hard left Jean-Luc Melenchon is now also in the running.
Credit Suisse says the election is the “greatest existential risk for Europe”, while JPMorgan’s Jamie Dimon warned that following Brexit, there is the potential for the EU to “split apart” if the French elections also upset the status quo.
It’s worth bearing in mind that the April 23rd poll only gives us the two finalists for the May 7th run-off vote. Therefore there are multiple scenarios to consider for traders weighing the risks.
THE CANDIDATES: A FOUR-HORSE RACE
Marine Le Pen – Front National (FN)
The extreme right is represented by Marine Le Pen. She’s vowed to take France out of the euro and a win for her is seen as a precursor to the disintegration of the Eurozone.
Chances: Polling around 23%, she’s been out in front for some time, but has come under some pressure of late from the hard left candidate, Jean Luc Melenchon, who shares many of her anti-globalisation views. A low turnout might be key: her support seems more solid than her centrist rivals.
Francois Fillon – Republicans (LR)
Fillon is mainstream but to the right of centre economically, markets would warmly welcome his election to the Elysee Palace as the mix of deregulation and rolling back government spending could deliver a big boost to businesses and French stocks in the process.
Emmanuel Macron – En Marche! (EM)
The ultimate centrist, the ex-Rothschild banker is seen as France’s Blair, offering an optimistic middle way between the extremes of right and left. A win for Macron would likely keep markets on an even keel.
Jean-Luc Melenchon – La France insoumise (FI)
The wild card: Melenchon’s late surge has upset the calculations and raises the prospect of a ‘nightmare scenario’ for markets that sees the hard-left nationalist face off Le Pen in the second round. He’s also polling around 20%, with support doubling in the last month. Although anti-euro, he has softened the language about his antipathy to the single currency lately as his chance of reaching the run-off increase. This is important – 72% of French voters want to keep the euro, according to a poll in Le Figaro published in March. A 100% planned top rate income tax would rattle many in the markets too.
The ‘nightmare scenario’
Analysis by Vanda Research puts the chance of a Le Pen-Melenchon run-off at 11%. Such a scenario would guarantee a major shift in France’s relationship with the EU and would certainly cause severe market gyrations. The chances of a big sell-off in the euro and French government debt would be extremely high.
There is also a 13% chance that neither will make the final vote, a result that would see markets sigh with relief.
The money at present is on Le Pen and Macron making the second round, which would hand the centrist a big chance of victory.
Even if we don’t get the ‘nightmare scenario’, a stronger-than-expected showing for Le Pen and/or Melenchon would disturb markets. What’s not know is just how much support Melenchon can garner from socialist candidate Hamon.
Can we trust the polls? As with the Brexit vote, Donald Trump and even the 2015 General Election, polls are not always a good indicator. Many French voters are undecided, while many might change their mind. Uncertainty is the only certainty and any of the 4 candidates could make it to May 7th.
Betting markets are instructive but also liable to get it wrong. At present they suggest Macron at evens will win the final vote, while Le Pen and Fillon are both at 3-1.
Of critical importance is how voters switch their vote for the second poll on May 7th. For example, can Le Pen capture enough of the Eurosceptic, anti-globalisation votes of Melenchon supporters to swing a majority? The complexities of this different scenarios for the second vote makes the potential for volatility high.
There are three reasons to be cautious:
We’re within the margin for error with polls – it’s just too close to call and there it’s possible for any of the four candidates to top the polls. Critically there are still a lot of undecided voters who could swing the vote. Around a quarter have yet to make up their minds and they could go in any direction. Apathy could also affect the result significantly as Le Pen’s supporters are much more likely to actually cast their ballots – a low turnout could hit the centrists (Macron, Fillon).
Polling data is not exactly gospel – polls have got it spectacularly wrong on two occasions lately – Brexit and the election of Donald Trump – so we should always be wary of making investment decisions on samples of voters who are liable to change their mind.
The Left – If socialist Hamon continues to bleed support to the hard-left Melenchon the latter could make the last two and with Le Pen seen as a strong contender we could end with the market nightmare scenario. A late surge for Melenchon should not be ruled out given the disillusionment among French voters.
Three ways to trade the French elections
Euro currency pairs offer some interesting trading opportunities. EURUSD is the most popular currency pair, but as a pure-play French election trade it has its problems. There are simply a huge number of factors impacting the euro-dollar cross, most notably Trump and whether the Federal Reserve is about to hike interest rates again soon.
A clearer risk trade is EURJPY. The Japanese yen is a traditional safe haven when markets go risk off and as the election poses fundamentals risks to European markets it is seen as a better gauge of investor sentiment. EURJPY has skidded 6% lower over the last month as currency traders fret about the prospects for the single currency. The potential for a further selloff in the euro is high if Le Pen and/or Melenchon outperform market expectations on Sunday.
European stock markets are exposed to the French elections but again the complexity of stock prices and valuations means a simple risk-based trade is complicated. As a wider gauge of market sentiment, volatility indices can be a useful indicator of market stresses, particularly as investors may get jittery leading up to polling day and especially in the hours before the results are known. The Eurex VSTOXX Mini Volatility Index is one of the ways to trade European stock market volatility.
French government bonds
Finally, French government debt, known as OATs, is an interesting trade around the elections. As polls showed Le Pen’s support rising we saw a widening of the spread between French government debt and German government debt (Bunds) as investors demanded a higher premium to hold French paper. Meanwhile the spread between French bonds and Italian bonds has narrowed to a three-year low. The result on Sunday should offer investors a clear signal whether to start buying again or whether there is cause for fresh selling.