The upcoming French elections have all the makings of the next event to have a profound impact on the financial markets, as a break-up of the Euro, the common currency for the European Union, is on the table. Following Brexit, the US election, and a lesser extent Italy, all eyes are now on France.
The Candidates:
Three candidates are in the lead and all of them have a good chance to make it to the second round. Le Pen, the most controversial candidate, has a real shot at being elected president, which could come as a surprise to investors, just like Brexit and the election of US President Trump.
François Fillon: nominee of the Republicans, the country’s largest center-right political party
- Prime Minister of France from 2007 to 2012, described as a reformist liberal
- Believes France, which founded the EU, is the right country to reform the EU
- Suggests to reinstate “real” border controls to prevent the influx of migrants
- Aims to reduce the public sector and cut civil-service jobs
Emmanuel Macron: nominee of En Marche!, a social liberal party founded in April 2016
- Prior Minister of Economy, Industry and Digital Affairs from 2014-2016, where he pushed through business-friendly reforms
- Sent strong Pro EU message
- Won support from the young and cosmopolitan (“winners from globalization”)
Marine Le Pen: nominee of National Front, a right-wing populist and nationalist party
- Won the FN leadership in 2011. Detoxified the party and softened its image, based on renovated positions and renewed teams
- Strong opponent of the Euro, advocates France to leave the common currency
- Pledged to pull France out of NATO (North Atlantic Treaty Organization)
Recently, the popularity of Le Pen has been rising.
Market volatility around the French election is expected to rise. Since December, 2016, in anticipation of the upcoming election, the volatility of French bond futures has spiked.
French elections are decided by popular vote, the top two make it to the second round, and the people vote again. The election process is somewhat simple and elegant compared to the multi-dimensional chess game that is a US election. The time between the first round (April 23) and the second round (May 7) allows for candidates to reach out to the voters one more time, and potentially create alliances with the other candidates. This did happen when Marine’s father, the famous Jean-Marie, defeated the left in the first round in 2002, and when the socialist electorate rallied behind Chirac, the right-wing candidate to ensure his resounding victory in the second round.
This election is void of the typical candidates; Francois Hollande dropped out, and so did Alain Juppe. They were viewed as the older and more conventional politicians. Similarly to the UK and the US, candidates portraying themselves as not part of the establishment, have a very strong appeal with the voters. And so, we are left with Le Pen, Fillon and Macron. Le Pen claims to be a true outsider, and makes sure to point out that her opponents are still part of the mainstream political establishment.
The importance of debates cannot be denied, in France historically, and especially with the immediacy of social media reactions to any tidbits, posturing on the stage, and other commentary or observations worth tweeting. Here again, Le Pen is ahead of her opponents, and portrays them as conventional, elitist pro-globalization, out-of-touch, lying politicians. When they try to cater to some of the strong nationalists and anti-immigration current, she then attacks them for trying to be like her in an attempt to garner votes. Both Fillon and Macron (Macron to a lesser extent) are somewhat lost in expressing a strong consistent vision that can arouse and excite the electorate, and are seen as compromising when they try to create consensus. While consensus and compromise are not the same things, sometimes in politics, lines get blurred.
Also, we do live in an uncertain world, and a riot in the suburbs, or a terrorist attack would clearly play into Le Pen’s hand. Those things unfortunately do happen, and they tend to happen either at times of heightened political tension, or times of maximum media impact. Le Pen is benefiting from the current investigation on Fillon and his family, and from what is perceived as a lack of traditional moral values on the part of Macron. These are topics she has been raising and will continue to raise during the debates.
Even more importantly, Le Pen is riding on the current wave of “patriotism versus globalization” as she has been keen to frame her movement from the start. US citizens have shown they want to put America first. They seem to be okay with the sacrifices minimizing globalization will have on their living costs and technology development, to make their voices heard against the establishments and the elites.
A similar sentiment exists in Europe and in France. France has had a long history of being on the receiving end of migration and waves of immigration. The current influx from Syria, has been one of the hardest to assimilate. The large numbers and the difference in culture and religion, being a leading cause. As a result, there is a very strong anti-immigration movement in France, paling in comparison to what we have seen in the US.
French people, by and large (just like the US or UK electorates) have a hard time seeing and understanding benefits from a strong union, or a common currency, or globalization. Many of the French would celebrate the return of the Franc. This is partially the fault of the elected officials, who have not been able to clearly articulate those benefits. Many of those benefits are long term and less tangible and cannot be explained in a headline or soundbites. Because of how most people now digest information, it is becoming harder to have meaningful discussions on the benefits of trade pacts on the disposable income, especially when you are competing with attention grabbing headlines.
At this moment in history, it is only natural for France to follow in the footsteps of their trading partners. If the UK is exiting, and the US is now seen as a threat to European countries (as was recently declared) it should not be a surprise if the French put their own interests first.
What should investors expect from the French election?
A loss by Le Pen would be accompanied by decrease in implied volatility and relative strengthening of the Euro against the British pound mostly. Also, quite likely is a convergence of the spreads between German and French bonds. We would also expect a material rally in European equities and a return to a global risk-on environment more broadly. Foreign allocation is at a trough, growth is rising and the pricing is attractive relative to European cash. Removing the political uncertainty would allow these economic fundamentals to dominate the asset’s pricing.
More interesting would be either a win by Le Pen or a period between the first and second round where her chances of winning increase. In the case of a Le Pen win, under the French constitution, where the elected president has even more power than the American one, she would be able to deliver on her promises.
This leaves investors with choosing the best protection trades. The traditional safe havens (Gold, USD, US treasuries) are themselves under pressure (except Gold) for their own local reasons.
US bonds offer protection against the post-election risk-off market action but are themselves under pressure from rising inflation and tightening US fed policy. The dollar will likely rally against EUR but if US rates fall then the USD response against other developed world countries will not be clear.
We see the following options as a protective hedge:
Buying the British Pound (GBP) and selling the Euro (EUR), as the GBP itself has been under pressure since 2014, something that has spectacularly accelerated since Brexit. A 10% move in that currency pair is likely, and would further gather momentum with increased talk of the Euro breakup.
French bond yields, and in particular the spreads to the German bonds can also rise quite drastically, potentially to 100 to 150 basis points within a few days.
Finally, we think it’s a good idea to run a low volatility portfolio and decrease one’s exposure to EU-centric assets such as European equities until the dust settles.
If Le Pen wins, the level of uncertainty in EU markets increases dramatically. Both the future of the EU as a union and the common currency will come under pressure. Euro will likely be hit heavily, as well as French equities and French government and corporate bonds.
