Mark Burgess, CIO EMEA and Global Head of Equities at Columbia Theadneedle Investments, considers the potential impact on markets of electing Le Pen, and the volatile consequences that this would have on French assets.
Since 2011 Marine Le Pen, leader of the French national conservative party the National Front (FN), has led a movement to 'de-toxify' the party, relaxing some of its more extreme positions and expelling controversial members of the party, including her father in 2015. Should she be elected president, her victory would signal change with the potential to alter the face of the EU.
Le Pen's key promise is likely to be a referendum on membership of the European Union, along with a desire to reinstate the French franc. While her promises to renegotiate a better deal with the EU will sound all too familiar (particularly to those of us in Britain), she is undoubtedly in a stronger negotiating position than the UK was. France is a key member of the monetary union and Brussels will be all too aware of the danger of a second exit.
If renegotiation with the EU (including a return of complete power over immigration controls and economic policy to France) does not result in a better deal for France, Le Pen will likely hold a referendum using Article 89. This requires approval of 3/5ths of parliament or the prime minister and, as such, either the make-up of parliament or who Le Pen appoints as prime minister becomes vital. There may be a chance that a strong-willed prime minister could put a spanner in the works and block a referendum on EU membership, but it's hard to envisage a government standing in the way of those who voted for Le Pen.
What can we expect from markets?
The immediate reaction of markets is likely to be a spike in volatility for French assets due to the uncertainty of what is to come. As a Le Pen presidency is perceived to increase the likelihood of France's withdrawal from the euro, in the event she wins the election we would expect the spread of French bond yields over German bunds to widen significantly. As a benchmark, that spread reached around 150bps at the height of the eurozone crisis in 2011/12 and it's quite possible that it would approach that level once again. Similarly, other peripheral and semi-core bond spreads would widen, consistent with an increase in break-up risk.
On the equity side, the European market could see a drop of as much as 10% immediately triggered by uncertainty about what this could mean for the EU, along with a potential wider hit to global markets. Companies with good fundamentals in sectors less impacted by geopolitical events should be fairly resilient. The largest hit will likely be European banks which could move down by 20-30%, having lowered 20% in response to Brexit. But Brexit is an arguably insignificant event in comparison to the break-up of the EU as with countries returning to their pre-euro currencies there will be a significant mismatch in assets and liabilities for banks still denominated in euros.
European banks have been at the precipice of a crisis for many years now, but it is not just those countries that are heavily indebted that will be affected by a Le Pen victory, it is also the likes of Germany (with its holdings of French and Italian debt). Certainly the interconnected EU banking system will be at the biggest risk of collapse, with consequences for the financial sector globally.
However the hurdles to ‘Frexit' would remain high and a more considered reaction may follow, even under a Le Pen administration. In this scenario some premium and curve steepness should probably remain, reflective of a more inflationary, less fiscally conservative policy mix. Likewise, French inflation-linked bonds, currently implying breakeven inflation rates of around 1.31% over 10 years, would perform strongly.
Looking further out to the medium term, if there was to be a break-up of the euro, this would cause the newly established franc to come under pressure as investors attempted to hedge risk by selling the currency. The traditional interventions to counteract a plummeting franc would include increasing interest rates in France and selling euro asset reserves to buy French bonds to help strengthen the currency. Such measures come with their challenges for a government trying to prevent damage to the economy and without a substantial euro-denominated reserve pool. As for other newly-resurging European currencies of old, the Deutsche mark would strengthen while the Italian lira would fall. There may in fact be a silver lining for Italy and Greece, in the form of the much longed-for depreciation in their currencies. The renationalisation of monetary policy would allow countries to devalue their currency, but would also magnify the issue of repaying euro-denominated debt.
The first round of the presidential election will be held on 23 April following which - should no candidate win a majority - a run-off election between the top two candidates will be held on 7 May 2017. In a world that feels increasingly unpredictable, all eyes will be on France.
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