Sun. May 29th, 2022

Markets are waking up to the possibility of a victory for far-right candidate Marine Le Pen in the 2022 French presidential elections, as are strategists. Here’s a quick wrap of what they’re thinking.

The FT’s main-page coverage has all the charts, pen portraits and procedure. To summarize, there’s a first round vote this Sunday and second round on April 24. The most likely scenario going by the polls is a rerun of the 2017 second-round runoff between incumbent Emmanuel Macron and Le Pen.

Barclays offers a why:

In a nutshell, the wartime leadership benefit that Macron enjoyed after the Ukraine invasion is fading now, with the campaign refocusing on domestic issues, in particular surging living costs and eroding purchasing power. Also, Macron is the incumbent, meaning all other candidates have been targeting him. Finally, the announcement of the pension reform and the so-called ‘McKinsey affair‘may have impacted his popularity.

It looks tight. Second round voting intentions show Macron leading Le Pen by about 5 points. Five years ago, Macron won in a landslide of 66 per cent versus 34 per cent for Le Pen. But that was after a lively between-rounds televised debate where Macron painted Le Pen as heiress to her rabble-rouser father.

This time around, Macron has a disapproval rating of around 54 per cent and has drifted rightward on security and cultural stuff, moving the Overton window towards Le Pen. Over to Nomura’s Jordan Rochester:

No sitting French president has been re-elected in the last two decades and hard-left voters have told pollsters they would rather abstain than re-elect Macron. Macron may also come under pressure with regard to yesterday’s news that the public prosecutor’s office has officially opened an investigation into the McKinseygate tax affair. Macro wise, 2022 brings high inflation, and the cost of living has become voters’ top priority. This is an area Le Pen is pushing hard in her campaigning.

Markets had until a few days ago been pricing in a status quo, as markets tend to. Since then the euro’s down, the CAC index has been underperforming and spreads between the French OAT and German Bund have widened. Yet there’s still a possible mispricing of risk that Le Pen and the other centered candidates, Eric Zemmour on the right and Jean-Luc Mélenchon on the left, do better on low turnout than the polls currently predict. Compared against the 2017 election there’s too much complacency and on Monday it might get a bit choppy, says Barclays, whose charts these are:

Turnout is the biggest complication. A Goldman Sachs model suggests 60 per cent of 1st round leftwing voters would need to abstain for Le Pen to be elected based on an equal split between the leading candidates:

Support for the EU in France is enjoying a Next Generation EU-subsidized boost right now so unlike in 2017, Le Pen isn’t campaigning to pull France out and abandon the euro. Her election would nevertheless trigger an EU crisis. Historic friendliness with Russia and pledges to tear up immigration and trade treaties aren’t compatible with the EU’s current French-German leadership.

Domestically, Le Pen has said very little capable of being costed beyond promising less cash for immigrants and more for gendarmes. Wealth and windfall taxes, a lower pension age for University of Life types, privatization (broadcasting) and nationalization (roads) make up the conventional populist playbook and are considered unhelpful for equities. Nomura summarizes the main policy differences:

While Goldman has a map of fiscal stances on corresponding growth impulses using component-level multipliers:

But a President needs a Parliament majority, elections for which are in mid June. Le Pen’s National Rally party does badly in parliamentary elections, holding just 6 seats out of 577 at the moment. Victory now would probably mean several months of bartering to form coalitions and markets, you may have heard, really do not like uncertainty.

What’s priced in? Not that much, maybe. Barclays’ basket of stocks with 20 per cent or more French revenue exposure has been underperforming the Stoxx Europe 600 by 3 per cent over the past week. European equities have been out of favor for quite a while though so that metric in isolation is hard to interpret:

FX wise, Nomura’s Jordan Rochester is a euro bear and sees no reason to change that view:

If EUR was trading at 1.09 into the election EUR / USD could drop to 1.05 on a Le Pen win, and then fall towards 2016 lows of just above 1.03. If Le Pen were to win the presidency and also the legislature in June it would be a much bigger deal with EUR / USD below parity in that scenario. . . If Macron were to win it would be the status quo and EUR / USD would likely rally slightly (0.5% to 1.0%). But we are also of the medium-term view that rising US real yields will weigh on EUR / USD. Even at these levels the risk-reward in the short term is for further EUR downside.

Why are [we] bearish EUR even without the election risk? We think there are still reasons for EUR strength to be contained. The European consumer still faces a crisis of confidence and energy prices remain far above established levels. It may still be too early for a conclusive ceasefire, but macro-wise we believe there is more to be priced into the Fed over the ECB, the euro area’s trade deficit is likely to widen and FX positioning is not that short EUR. This is why we expect EUR to remain under pressure in April.

Goldman’s the opposite on FX, saying the Ukraine war and an energy crisis have been bringing Europe closer together, but comes to a similar conclusion for risks. Here’s its rates download:

We would expect this time the main impact of a Macron loss would be through the integration axis, lowering the upside tail for EUR / USD.

On the basis of our rates strategists’ modeling described above for peripheral spreads (ie trading about 30bp tighter than ‘fair’ value), this likely embeds some market expectation of a political backstop to sovereign risks. A change in the French presidency would likely see this more than reverse, and bring some sovereign stresses back to the forefront. Under this scenario, we could see EUR / USD trade lower by about 2% (but even a tighter-than-expected first round result should only partially price this scenario). This expected downside is considerably smaller than our 2017 estimates, which reflects the shift away from the ‘Frexit’ debate.

What the above suggests to us is that the key dimension of the presidential elections in France is likely to be European rather than lying in domestic policies. In our view, this is an important fracture line between incumbent President Macron and his main opponent, far-right candidate Marine Le Pen. Indeed, while the latter is no longer explicitly advocating for Frexit, and has generally toned down her anti-European rhetoric, she would likely adopt a more antagonistic stance with respect to European institutions; at the very least, her election could mean that France would stop being a proponent of further European integration. For that reason, on rising odds of a Le Pen victory, we would expect OAT-bunds, and other sovereign spreads, to widen meaningfully.

How much spread widening to expect? We would first look for a reversal of the sovereign credit performance observed in March as odds of further area-wide policy support drop. Beyond that, the 2017 presidential elections can help us gauge the potential additional upside in the event of a Le Pen victory. Assuming Frexit is off the table (and that domestic policy is constrained by legislative bodies), the risk premium in OAT-bunds should remain more contained than in 2017. However, the European context described above implies larger spillover coefficients than at the time, in our view .

All told, in this adverse market scenario, we expect 10y OAT-bunds to land at 60-75bp, and 10y BTP-bunds at 180-210bp. Conversely, if Mr. Macron is re-elected with a legislative majority – our base case – the potential for spread compression looks limited in the current macro environment, given the skew of risk around inflation and ECB policy tightening. We continue to recommend 5y OAT shorts against EU bonds going into the elections.

French law prohibits local media from publishing exit polling results before 8pm EST (7pm in London, 2pm in New York) but foreign media are exempt, so it is possible that early results might be leaked. Good luckeveryone.

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