French election watch: Risks and opportunities ahead
The consequences of this year’s French presidential election – negative or positive – are likely to be long-lasting. Ahead of them, a strange mixture of nervousness and complacency seems to have taken hold in European markets with bond spreads, for example, so far proving much more sensitive to election campaign developments than equities. Bond investors appear increasingly willing to consider risk scenarios, even if these have only a small chance of occurring.
Before we talk about the election itself and its investment implications, it is important to understand the strengths and weaknesses of the French economy and economic governance. These have potentially profound political and therefore market implications. France is the second largest economy in Europe but growth is trailing behind the Eurozone average, unemployment remains high, and competitiveness indicators are mixed. The French “malaise” is not just affecting poorer, possibly unemployed members of the community, but the business community as a whole.
The political implications of sub-par economic performance are amplified by expectations around the role of the administrative state in French society. Popular expectations around state provision are high but increasingly are not being met. One result is a growing distrust of the administrative elites and a desire for change – but what is wanted is more effective provision, not a desire to dismantle the state itself.
The policy promises of most of the presidential candidates reflect this essential conservatism. The consensus remains that Le Pen will make it into the second round of the presidential contest but will then be beaten by Macron or Fillon. In this case, we estimate that the French-German 10-year government bond yield spread could move towards the 30-20 basis points lows of recent years. This scenario would give the euro some relief via capital inflows and EUR/USD could temporarily revisit the level of 1.10, before the US economic stimulus could push it down again. Eurozone, and especially French and Italian equities, might gain about 5-10%.
But it is also worth evaluating the risk scenario of a Le Pen win. The impact of this would be felt across the European periphery in both bond and equity markets. We estimate that Italy and Spain would see their bond yields rise to levels not seen since the bond crisis of 2011-2012, while equities might fall by around 10%. As France is Germany’s most important economic and political partner, the Euro may fall not just against the US dollar but also against the Japanese Yen and the Swiss Franc, as market sentiment switches to risk-off mode.
The implication is that, even if a Le Pen victory remains improbable, just a small possibility of such an outturn could still unsettle European markets as the election approaches. Volatility and market timing should remain important issues, even if the European economic backdrop continues to improve. It is also important to remember that the presidential election, in itself, will solve nothing. Le Pen’s strong showing so far has been a warning shot and the eventual victor must address the economic and policy problems that have assisted her rise. Markets may also soon start to focus on the implications of the June 2017 French parliamentary elections for economic governance and investment.
Christian Nolting is global chief Investment officer, and Stéphane Junod is chief investment officer, EMEA, at Deutsche Bank Wealth Management.
20 Apr 2017