Key takeaways

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  • Eurosceptic National Front (NF) candidate, Marine Le Pen, is currently projected to reach the second round of the French Presidential elections, before losing out to Emmanuel Macron
  • In the event of a Le Pen victory, enacting her more radical proposals will require a French exit from the European Union (EU). This is very unlikely due to constitutional barriers, a lack of NF seats in parliament and a pro-EU French population
  • Given this, our core asset class views are unaltered. We remain overweight Eurozone equities and underweight Eurozone government bonds

Le Pen expected to reach second round

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Following the non-event of last month’s Dutch elections, investor attention now turns to France’s two-round Presidential elections. The latest polls indicate that Marine Le Pen, National Front (NF) candidate, and Emmanuel Macron, running under the banner of his En Marche! party, are leading in the first round (on 23 April). Although Macron has consistently led Le Pen in the two-way second round run-off (on 7 May), by around 20 percentage points, spreads between French and German government bond yields have edged up, reflecting the risk of a Le Pen victory (Figure 1).

Figure 1: Spread between French and German government bond yields, and implied probability of Le Pen final victory

Figure 1: Spread between French and German government bond yields, and implied probability of Le Pen final victory

Source: Bloomberg, Oddschecker, as at 12 April 2017

This perceived risk mainly stems from her promise of a referendum on European Union (EU) membership if certain terms cannot be renegotiated, such as leaving the Schengen visa-free zone or reinstating the franc. The NF has stated it could redenominate about 80 per cent of the country’s debt into francs. Concerns also revolve around her pledge to introduce protectionist policies, such as an import tax.

A high abstention rate is likely to benefit Le Pen, with a recent poll by Elabe showing her voter base as relatively more committed (81 per cent), especially versus Macron supporters (67 per cent). Le Pen could also gain from facing a resurgent far-left Jean-Luc Mélenchon in the second round, as the anti Le Pen vote is less likely to coalesce under a similarly extremist candidate.

Very low risk of “Frexit”

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The EU are unlikely to agree to Le Pen’s stated demands. This makes a French exit from the EU (“Frexit”) the only route in achieving her goals. However, the risk of “Frexit” remains very low. Membership of the EU is enshrined under Article 88 of the French constitution. Crucially, Article 89 states that any constitutional change needs to be proposed by the government, not the President, and then approved by both houses of parliament. This is unlikely. The NF have only 2 seats each in both houses. The 11 and 18 June lower house elections could see the NF gain seats, although there is a long way to achieving a majority (289 out of 577 seats). Furthermore, only half the seats of the upper house are up for grabs in September elections. With elections every three years, this implies the earliest date the NF can control this chamber is 2020.

Ultimately, this will hinder Le Pen in appointing a like-minded Prime Minister. Organising a referendum will also be difficult, as this requires government or parliamentary involvement (Article 11), and a sign-off from the constitutional court (Article 61).

Finally, according to a recent Eurobarometer poll, 58 per cent of the French public disagree that their country could “could better face the future outside the EU”, implying that even if a referendum on EU membership were held, a majority would vote to remain.

Investment implications

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Markets are currently pricing in Le Pen to reach the second round run-off, before losing to a more mainstream candidate. However, if she performs better than expected in the first round, or faces the extremist Mélenchon in the second round, we could see a sell-off in European equities and French/peripheral European government debt. This would be magnified in the event of an outright Le Pen victory on 7 May. In such an eventuality, we would expect the European Central Bank (ECB) to be on hand to prevent any severe market dislocations.

Le Pen enacting some of her more radical proposals – reinstating the franc, leaving Schengen, imposing import taxes – is likely to require “Frexit”. This seems very unlikely for the time being. Therefore, we continue to have an overweight view on Eurozone equities, given relatively attractive valuations.

Meanwhile, European government bonds remain overvalued in our view, and we maintain our underweight position. Although the premium attached to French redenomination risk is probably being overestimated, we are in a bond-unfriendly environment. A reduction in ECB bond purchases amid robust activity data remains a key risk to the outlook in this respect. As always, as developments unfold, we will review positions on an ongoing basis and adjust portfolios accordingly.

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