Global Daily – French political risk is back!

by: Aline Schuiling , Kim Liu

Euro politics: Tensions surrounding French elections rise – Uncertainties about the outcome of France’s presidential elections (first round on 23 April and second round on 7 May) increased during the weekend. The left-wing populist Jean-Luc Mélenchon has risen in the polls to a joint third with centre-right François Fillon. Thus Mr Mélenchon can no longer be neglected as a potential candidate for the second round of voting. Although the polls for the first round still show that centre-left Emmanuel Macron and Eurosceptic populist Marine Le Pen are neck-and-neck to take first and second place on 23 April, the gap between them and Mr Mélenchon is about 5% of the votes, which seems small considering that approximately 30% of voters are still undecided. Mr Mélenchon’s agenda blends populism, institutional scepticism and radical left-wing economics. He advocates a drastic redistribution of wealth, increasing the minimum wage, hiking taxes for high incomes, exiting NATO, re-negotiating European treaties, cutting the working week to 32 hours, abandoning nuclear energy and rewriting the constitution. Moreover, he proposes a public spending stimulus of EUR 100bn (4.5% GDP) to tackle poverty, improve public services and protect the environment. Polls for the second round of voting, which include Mr Mélenchon as a contestant are still scarce and should be taken with a pinch of salt. Still, they show that if he were running against Marine Le Pen he would beat her by a wide margin, whereas against Emmanuel Macron he would lose, but by a smaller margin. Although the uncertainties have definitely risen, our base case scenario remains that Mr Macron will be the next French president. (Aline Schuiling and Jean-Paul Honegger)

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Euro government bonds: French bonds under pressure in run up to elections – With less than two weeks to go before the first round of the French presidential elections, French bonds have fallen under renewed pressure. The generic French-German 10-year spread has widened to over 70bps, up from below 60bps at end-March. The revival of French political risk is caused by the rising popularity of left-wing populist Jean-Luc Mélenchon (please see above for more details). His surge in popularity is bad news for French bonds as the policy plans of Mr Mélenchon are perceived to be much less investor friendly than those of, for example, Mr Fillon or Mr Macron. Although our base case still includes an eventual Macron victory in the second round, investors are pricing in the additional risk of a surprise win for Mr Mélenchon. What is more, from data disseminated by the Japanese Ministry of Finance, it became clear that Japanese investors sold a record amount (JPY 1.52trn) of French bonds in February. This was the fourth month in a row during which Japanese investors sold French sovereign debt. If Japanese investors are taken as a proxy for total demand by foreign investors, the data suggests that French bonds are persistently losing investor support. This could continue as we draw closer to the elections and means that volatility could increase. In our base case scenario of a Macron victory, we expect the French-German 10-year spread to fall back again and stabilise at around 50bps. However, in the event of a Mélenchon or Le Pen victory, the spread is expected to be much higher. Especially in the case of a Le Pen victory, in which the future of the eurozone could be under threat, the spread could balloon back to crisis levels of around 200bps. In the event of a victory by Mélenchon, we would be also expecting a jump in the spread to well above the current levels. (Kim Liu)