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Apr 21, 2017 03:20 PM IST | Source:

Brace for volatility as France votes in a four-way race to elect President on Sunday

Investors ultimately expect victory from the centrist Emmanuel Macron but are fretting over the likelihood of a strong showing by either far-Right candidate Marine Le Pen or far-Left candidate Jean-Luc Mélenchon.

Global markets, which have had to weather a Brexit and a Donald Trump victory, are now edgily watching the first round of the French elections slated for Sunday. The polls show a nail-bitingly close race between four candidates, setting the stage for heightened volatility.

Investors ultimately expect victory from the centrist Emmanuel Macron but are fretting over the likelihood of a strong showing by either far-Right candidate Marine Le Pen or far-Left candidate Jean-Luc Mélenchon. Two candidates qualify for the second and final round on May 7.

The main risk of Le Pen or Melenchon getting to the final runoff and coming to power is that it could spell the beginning of the end for the eurozone. Investors globally have been hedging ahead of the vote by piling into safe haven assets like US Treasury and gold, and buying yen against the euro.

A surge in the polls by Melenchon has again reminded investors of the anti-establishment sentiment sweeping across large parts of the world, and underlines the fact that this feeling can be harnessed for their ends by the Left as well as the Right, even if the latter has been the bigger beneficiary in recent times.

Le Pen is also doing well in the polls and has a high probability of getting one of the two spots in the runoff. The big question is who will she face in the second round?

The market’s favourite is Macron. This 39-year-old former banker has never held public office and has emerged as France’s last, best, and perhaps only chance of staving off Le Pen to emerge as president in May. The other centrist, Republican François Fillon, has a slender hope. But what could rattle markets more is a victory for Melenchon, who has promised to rework the treaties that set the framework for the EU and then hold a referendum on whether to remain in the bloc.

Depending on how well Le Pen does in the first round, the market could react quite violently. If her runner-up is 6, 7 points behind her, many people would see that as her victory.

It is an easy generalisation to say if Le Pen wins, France pulls out of the euro and the EU collapses. For France to pull out, there has to be a vote in parliament. There is a parliamentary election in June, and it in fact could be the more important election. Nevertheless, the Presidential election will help gauge the mood of the nation.

The bigger near-term risk is a Le Pen victory which could foster other nationalist groups in Europe.

The cost of France’s government debt — the yield it pays on its bonds, known as OATs — has generally been close to that of Germany's, reflecting their status as being among the safest of sovereign debt to own. However, recently this relationship has begun to break down: since late 2016 the yield that France pays on its 10-year bonds has risen sharply relative to Germany’s. In February, the OAT/Bund relationship touched its highest levels since mid-2012, amid the worst days of the eurozone crisis.

France-Germany 10 Year Bond Spread is currently at 0.78 percent, compared to 0.36 percent last year.


Last week the spread between French and German 10-year yields was back near those highs after polling suggested a swing towards the leftwing Mélenchon. The rise in yields means that French sovereign bonds have begun to perform more like those of peripheral eurozone economies such as Italy.

Experts predict that the worst of all outcomes for the market, a Le Pen-Mélenchon second round, could see the 10-year spread back at its 2011-12 eurozone crisis highs. Even a Macron-Le Pen face-off would not calm markets entirely.

While markets are likely to gyrate contingent on the outcome of the Sunday polls, we have seen time and again that such ructions pass fairly quickly, and while they last, bring valuations to a reasonable level for investors.
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