French Elections Update

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Includes: EWQ
by: Xavier Attala

Summary

Markets have started to price in the risk inherent to French elections.

Jean-Luc Mélenchon surge in polls should not be underestimated.

How markets would react to the different 1st round outcome hypotheses?

This week European markets have started to price in some risk implied by the outcome of this crucial elections. De facto the risk of a surprise regarding the issue of the election is way more important than it was at the end of 2016. At that time, main political divisions were still in place. At this point, the candidates representing them have fallen dramatically. François Fillon, representing the temperate right movement, has fallen 7 points from 25% to 18% due to recent scandal and indictment. Benoît Hamon, the socialist candidate, is now below 10% from its highest of 18% in January, hit by the unpopularity of the current socialist government and the doubt on his presidential stature. Another notable development is the recent rise of Jean-Luc Mélenchon fed by the success of his anti-establishment rhetoric and his posturing as a smoother alternative for a radical change than Marine Le Pen.

As a matter of fact, the political landscape in France has completely changed from what we have seen in previous elections. First, the presence of the extreme right at the second round has become a certitude rather than a surprise. Its popularity and influence has been driven by the terrorist attacks in the past 3 years and the desire for a radical change. Second, there are now 4 potential candidates who could make it to the second round. The PS not being one of them is also a big novelty in French politics. Furthermore, each of these candidates is almost assured to achieve victory against the FN leader.

Source: "Kantar Sofres - onepoint" , 10 April

The spectacular ascension of Emmanuel Macron has reassured the markets.

The former economy minister of the current unpopular socialist government appears as the favorite to face Marine Le Pen in the second round with 24% in the polls (Chart above).

Up to now, markets have been optimistic on the outcome of the election. In fact, before last week the only two conceivable scenarios according to the opinion polls were a second round with either Emmanuel Macron or François Fillon facing Marine Le pen. In neither case, is the FN likely to make more than 50% of the votes.

However, the recent surprise events that jolted this election campaign have completely changed the context. With the LR candidate indicted. His popularity and vote intentions have been smashed by medias and opinion. The probabilities of him reaching the second round are very limited now.

The unexpected rise of the outsider: The far left and eurosceptic candidate, Jean-Luc Mélenchon

The most notable change in fact is the surge of Jean-Luc Mélenchon, his intentions of vote have rallied in the last three weeks. Moreover, according to this recent survey, he is in second position behind Emmanuel Macron in terms of voting potential.

Source: "Kantar Sofres - onepoint", 10 april

This current advance of Mr. Mélenchon opens the possibility of a third scenario: a second round opposing the far-left and the far-right candidates. In that case things could get ugly, and the markets are showing signs of risk rising across European assets. To be sure, both candidates suppose a great risk for the sustainability of the current system and the economy. Their economic guidelines are both seen as unrealizable and are likely to endanger the European Union and its common currency. However, euro politicians are less scared by the far-left candidate Jean-Luc Mélenchon than Marine Le Pen (Source: Les Echos).

Is there a real possibility for the far-left candidate to achieve the second round?

I believe probabilities are surging for two main reasons. First, a characteristic of this election is the need for real change. As a matter of fact, French people are disappointed with their traditional politics.

Second, the decline of the socialist party in the opinion polls and the Fillon case, are the main drivers of Jean-Luc Mélenchon rally in the polls.

Source: STOXX.COM

Bonds also started to price in the rise in opinion polls of the far-left candidate with the German/French spread 60% to 78%

Source: YCHARTS

In my opinion this disruption in the French political landscape will continue to contribute to the growing incertitude over the first-round outcome. Moreover, with the current evolving and delicate environment in Europe and, in fact, the whole world, it would not be a surprise to see more unexpected changes in opinion polls and votes outcome.

As a result, indecision keeps growing. According to an "Elabe" study the share of undecided voters is down 3% staying though at 27% (Source: Les Echos).

In addition, if you consider the current track record of opinion polls in predicting election outcomes, as well as the small gap in vote intentions between candidates, an unexpected scenario appears to be more than likely.

D-5, The gap between candidates in the opinion polls is tightening.

This current situation is driving up the level of uncertainty around this election. Right now, according to these polls (table above) any of this candidates except Benoît Hamon could now without any doubt reach the 1 st round of the election. This leave us with 3 probable hypotheses in which Marine Le Pen would reach the second round and two others were the far-right would not make it.

Conclusion: The different scenarios and what to expect in terms of market reactions.

Senario nº1: Le Pen vs Emmanuel Macron :

If we stick to what the latest opinion polls are saying, The FN leader will face the young centrist candidate of the 1 year old party "En Marche!". According to research (source: Kantar - Sofres - onepoint) Emmanuel Macron will easily beat the far-right leader with 61%. I agree with this, since the current left voters would never give their vote to the far-right candidate. Furthermore for the François Fillon supporters the "En Marche !" candidate appears as reasonable solution. Moreover, his traditional education and financial background in addition to the support of more than 20 economists (source: Le Figaro) puts him as a safe and reliable alternative.

Then in my view European markets will appreciate this hypothesis becoming true. They will probably anticipate his victory at the second round. Markets will recover the recent losses and go even higher just after the first round. Driven by enthusiasm and optimism about the future.

Scenario nº2 : Le Pen vs F. Fillon:

A similar situation has already been seen in the past. In 2002, the temperate right candidate Mr. Chirac faced Mrs. Le Pen's father in the second tour. The FN lost, French people and left voters gave they vote massively to Mr. Chirac allowing him to beat his opponent with an 82.21% majority.

In that case for markets this would also be a relief, and in France some sectors like real estate would cheer the victory of Mr. Fillon more than an Emmanuel Macron victory, in my view. For European markets, I anticipate a similar reaction than for the hypothesis nº1.

Scenario nº3: Le Pen vs Jean-Luc Mélenchon:

For European markets, this is the apocalypse. Both are Eurosceptic, and I believe, for markets and the French domestic market the far-left candidate is even more dangerous due to his strong communist convictions. In addition to the drastic and blurry changes he has announced.

This scenario would lead European markets to a bearish situation, uncertainty would rise. The single currency and the European union will obviously be in danger. However, note that according to a "Les Echos" article, Some European commission politicians see in Jean-Luc Mélenchon a better alternative than the extreme right.

Finally, the consequences of this scenario would be disastrous. It will be the opposite of what we have seen in markets after Brexit vote, they will not recover, in my view. At least not as fast as they did after Brexit.

There are also two other hypotheses were the far-right would not reach the second round.

As it is shown on the table above there are two other hypotheses. One of them is Emmanuel Macron facing François Fillon in the second round. In that case, I believe markets would react positively after the 1 st round outcome. The other scenario would be a second round between the far-left candidate Jean-Luc Mélenchon and Emmanuel Macron. In my view markets would react negatively to this 1 st round outcome hypothesis.

*Thursday Paris was hit again by a terrorist attack. An armed man attacked a police vehicle on the Champs Elysée. A policeman has been killed during the assault. This sad event will inevitably influence the election.*

Disclosure: I am/we are long EURO STOXX 50 (CFD).

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.