"Fool me twice, shame on me,” goes the idiom. Caught out by shock victories for the Leave and Trump campaigns in 2016, investors are determined not to let political risk get the better of them a third time as the French presidential election approaches this spring.
Since the beginning of the year, French government bonds have sold off as fears have intensified that the Eurosceptic, protectionist firebrand Marine Le Pen will find a route to the Elysee Palace. The spread between 10-year French debt and safer German bunds of similar duration yesterday reached its widest since August 2012, as investors have fled to German notes bearing lower credit risk.
Some of this is down to the European Central Bank’s decision to increase the proportion of German bunds it buys under QE, but as Le Pen has consolidated her position as the most popular candidate, it is easy to see why markets are scared.
When her party, the Front National (FN), launched its manifesto earlier this month, it detailed plans to renegotiate France’s relationship with the EU over six months. The FN wants the bloc to agree to abandon the euro and would redenominate 80 per cent of France’s national debt into francs, a move which the head of sovereign ratings at S&P has said would be tantamount to a default.
However, a Le Pen win is still considered unlikely. “Financial markets are perhaps exaggerating the risks,” says Sandra Holdsworth, co-manager of the Kames Capital Absolute Return Global Bond fund. Indeed, there are a number of barriers in Le Pen’s way.
First, turnout is normally high for French elections, and Le Pen would need an absolute majority in the second round which no polls predict she could achieve. An Opinionway poll published yesterday estimated that Le Pen will win the largest share of the vote (27 per cent) in the first round, but would lose to whomever she faced in the second round – which is likely to be either centre-right Republican nominee Francois Fillon or the centrist Emmanuel Macron. JP Morgan economists put her chances of overall victory at 14 per cent.
Financial markets are perhaps exaggerating the risks
French voters have a strong tradition of rallying around the most moderate candidate in the second round – a phenomenon which saw Le Pen’s father, FN’s founder, suffer a thumping defeat to Jacques Chirac in 2002. The European Commission’s Euromonitor surveys also show that the French public do not share her hostility to the euro.
So why all the worry? Even if there is only an outside chance of Le Pen winning, economists broadly agree she would be a disaster. David Rachline, the FN head of strategy, has talked about swapping euros for new francs on a one-for-one basis, implementing a peg to the single currency, and converting €1.7 trillion of France’s €2.1 trillion of public debt into the new currency. JP Morgan has said that French corporate debt would also have to be redenominated, and could trigger a credit event. But even if avoided, the franc would quickly lose parity with the euro anyway.
Jessica Hinds of Capital Economics points out that manufacturing unit labour costs – viewed as a broad measure of price competitiveness – have been much higher in France than the Eurozone as a whole since the single currency was introduced in 1999, so a devaluation in the franc would probably occur. This would be compounded by inflation imported from the Eurozone through more costly euro-denominated goods. Hinds predicts that the new franc would fall 10-15 per cent, even before accounting for a likely fire sale of French assets.
Euro periphery countries would be even more vulnerable to the Eurozone disintegration which could plausibly follow France’s rejection of the single currency. “France is a very solid AA-rated country credit, while Italy is a very weak BBB-rated country,” says Holdsworth. “A change of the magnitude Le Pen is talking about would probably push [Italy] into sub-investment grade, which would have very negative consequences.” However, a Le Pen win is far from Kames Capital’s base case.
A close call
But for anyone following the twists and turns of this election campaign, writing Le Pen off entirely looks foolish.
Fillon was leading polls until last month, when it emerged that he had used public money to pay large salaries to his family during his tenure in government, with little to show for their work. Yesterday’s Opinionway poll has Fillon taking 20 per cent of the vote in the first round, the same proportion as Macron, leader of the newly founded En Marche party. After calling France’s colonial history “a crime against humanity” last week, Macron too has seen his popularity decrease, and given the lightening speed of his ascent, there are concerns that his base of support is not as established as Le Pen’s, who has broadened out the FN’s social conservatism and anti-immigrant stance to embrace an economic nationalism which appeals in a country with high unemployment.
“Both Macron and Fillon promise reform,” says Famke Krumbmüller, partner at OpenCitiz, a political risk consultancy. “Fillon proposes €40bn in favour of companies by decreasing employers’ charges, he wants to simplify the labour code and reduce corporate tax to 25 per cent.”
It is likely, however, that neither would reach the second round if the two leftist candidates – the Socialist Benoit Hamon and Jean-Luc Melenchon – agree to unite behind a single candidate. Talks between the two broke down this weekend, but polling suggests that an eventual arrangement would guarantee a President hostile to markets. In an otherwise unpredictable election, Le Pen’s presence, and the strength of her support, seem to be the only constants.