The upcoming French presidential election is giving investors around the world cold sweats. They all fear a last minute surprise, as was the case with the last US presidential election, which could put a populist politician at the head of fifth world economic power. As a matter of fact, Marine Le Pen has a strong lead in the polls. In recent weeks, she has taken advantage of the « Penelopegate » scandal and anger in France’s most deprived suburbs to gain more ground.
In the first round, she could get around 27% of the votes, significantly ahead of all the other candidates. In the second round, a recent poll showed that she could get above 40% of the votes (43% against François Fillon and 42% against Emmanuel Macron), while she was much lower a few weeks ago (around 35% of the votes). Releasing a new poll during the presidential campaign almost every day is a longtime French tradition. Other polls need to confirm this growing
trend. Nevertheless, it seems already evident that the presidential race is tightening and that the Front National has never been so close to reach power, which is enough for investors to panic.
The « Le Pen effect » is real
On financial markets, the « Le Pen effect » is already noticeable:
– Investors are increasingly speculating on the French sovereign debt. The volumes traded on the French debt exploded last January to reach 236.1 billion euros, which corresponds to a 40% increase compared to the monthly average of last year (source: Trax);
– The French bond spread remains close to 80 basis points which is its highest level of 2012. A few months ago, it was only around 20 basis points;
– French CDS has just crossed the level of 70 basis points whereas it was around 40 basis points at the end of January;
– Economic policy uncertainty index for France is at all-time highs whereas European economic uncertainty has been decreasing from its 2016 peak;
– The CAC 40 has been underperforming other European stocks since the beginning of the year. Despite a good earnings season, the French index has decreased by 0.3% whereas the Dax has jumped by 1.9% and the FTSE 100 by 2%.
– The 2y German sovereign bond « Schatz », which is a traditional safe asset to overcome EU uncertainty, trades at a historically low level close to -1%.
Breaking the glass ceiling is quite a challenge
As a French citizen, foreign investors’ fear (they hold about 60% of the country’s sovereign debt stock) is quite overestimated and is mostly linked to ignorance of the French political and institutional system.
– Polls are reliable. Vote in favor of the Front National is well-estimated by polls, which was not the case for Trump or the pro-Brexit movement since they both were new political phenomenon quite difficult to quantity. A few years ago, the Front National’s supporters were reluctant to express publicly their political orientation and in all the polls their vote was significantly underestimated (which explains why they failed to predict Jean Marie Le Pen’s second-place finish in the 2002 presidential election). However, this is no longer the case. Therefore, there should not be major surprise about the Front National result;
– Exceptional historical circumstances would be necessary for the Front National to win, such as an unprecedented drop in the participation rate. During the Fifth Republic (since 1958), the average participation rate is at 80% in the first round and 81.5% in the second round. In all the elections in which the Front National is qualified for the second round, there was a noticeable increase in participation (+8 basis points for the 2002 presidential election and for the 2015 regional election where the extreme-right wing party was qualified for the second round in 13 regions out of 18 but did not win any). Many studies confirm that voters systematically adopt the most appropriate behavior to avoid the victory of candidates or lists of the Front National;
– Marine Le Pen won’t be able to get enough votes to cross the decisive threshold of 50%. Under the assumption of 10 million votes in the first round and a participation rate of 81.5% in the second round, the Front National needs an extra 8 million votes to win. The challenge is even more difficult if the participation rate increases which is usually the case when the Front National is qualified for the second round. Assuming a participation rate of 87% (equivalent to the level of 1974 which is the highest rate for a presidential election under the Fifth Republic), the party needs an extra 9 million votes to win the second round. Taking in consideration Marine Le Pen’s highest score in polls in the second round (43% of the votes), in all possible scenarios, she still lacks an extra 2 to 3 million votes to become president;
– To become president, it is crucial to win the votes of those 60 and over. Elderly voters tend to vote the least for the FN due to exit from the euro and the potential impact on savings, and have the highest participation rate in all the elections (87% in the second round of the 2012 presidential election against 80% for the entire electorate). Recently, the Front National has tried to soften its anti-EU stance but it is unlikely that it will cause a change of heart for elderly voters that are usually more incline to vote for the right-wing candidate (in this case, François Fillon).
All this seems to indicate that Marine Le Pen has a very little chance of becoming president in 2017.
…And if Marine Le Pen makes the impossible possible?
At the institutional and political level: Marine Le Pen would quickly be in the uncomfortable position of a president of the Fourth Republic who is deprived of all real power. Indeed, it is almost certain that the Front National won’t be able to secure a majority at the Parliament at the occasion of the legislative elections scheduled on June 11 and 18. Therefore, the country would be in a situation of cohabitation. This would be the fourth time since 1958 and the first time since the referendum on the presidential quinquennium in September 2000 which was aimed at avoiding cohabitation as much as possible by aligning the duration of the presidential mandate with that of the Parliament deputies. The cohabitation will prevent Marine Le Pen from organizing a referendum on membership of the EU, as she planned to do after negotiating a « better agreement » with Brussels. Although recourse to referendum is a prerogative of the President (Article 11 of the Constitution), it can be only be organized on the proposal of the government or on a joint proposal by the National Assembly and the Senate. Even if elected, Marine Le Pen would not be in position to implement most of her economic and European measures.
For the CAC 40: It is quite easy to anticipate the French equity market would take a steep dive in the aftermath of Marine Le Pen’s victory. Historically, the French presidential election has a marginal impact on financial assets. The only election of the Fifth Republic which had a notable consequence was that of 1981 and resulted in the victory of the Socialist candidate François Mitterrand. Over the 30 days following the first round, the CAC 40 has dropped by almost 20% as investors were afraid that the « Soviet tanks would parade on the Champs Elysées ». A similar turnaround is likely if the Front National wins, at least until foreign investors realize the new president is impotent.
For France’s borrowing costs and fiscal sustainability: The major fear of foreign investors is a strong rise in interest rates linked to political risk. In 2007, France’s debt-interest payments (which are the second largest area of state’s expenditure) accounted for 2.5% of GDP and only 1.7% in 2016 as a result of reduced interest rates and despite the significant increase in public debt. France’s debt-interest payments as percentage of GDP is lower than most European countries (UK, Italy, Spain), with the exception of Germany. Due to the long maturity of the French debt (7 years), a movement in interest rates of 1% has an annual impact of only 0.14% in debt-interest payments. Even in the case of jumping interest rates, debt-interest payments is expected to keep declining in 2017 and 2018 (reaching around 1.5% of GDP) by cause of the repayment of debts already issued in the midst of the 2007 financial crisis. Under the assumption that 10y French sovereign bond yield is at 4%, annual inflation rate at 2% and annual GDP growth at 1%, all other things being equal, it is only at the beginning of the 2020s that the debt-interest payments will be close to its 2012 level. Consequently, the effect of higher interest rates linked to the « Le Pen effect » (which is not likely to last) or to external events such as the overall increase in inflation should not have a significant impact on public finance during most of the upcoming presidential term.