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WINDS OF CHANGE IN FRANCE?

2017 – A fateful year for the EU

After last year’s surprise outcomes in the Brexit referendum and the US presidential election, the capital markets are now focusing on the upcoming elections in the euro zone. Worried investors are looking ahead in particular to the French presidential elections, where according to the most recent polls, Marine Le Pen, outspoken opponent of the European Union,  is riding high. France occupies an undisputed central role in the EU and the consequences for the capital markets of an election victory for Marine Le Pen would significantly outweigh those of Brexit.  

 

Higher Risk Premium ahead of the election

Accordingly, in the run-up to the presidential election on 23 April (first ballot), the risk premium on French government bonds has already significantly increased since the beginning of the year. After a return of 0.1% from OATs with 10 years maturity in Q4 of last year, these are currently yielding 0.9% – despite bond purchases by the ECB. This risk aversion becomes even more visible in the development of the interest differential between French government debt and German Bunds. The interest mark-up on comparative bonds has widened from 25 basis points at the beginning of the year to currently 70 basis points. Leaving aside the peak phase of the euro debt crisis in 2011, the current risk premium is the highest since 1995. The 25-year average for this interest differential is 39 basis points. The mood in France has thus had a significant deteriorating effect on the markets.

Macron VS. Fillon

At this time, the perception of the capital markets appears somewhat one-sided. The outcome of a victory for the other possible presidential candidates could herald long-awaited structural reforms in France. Republican candidate Francois Fillon and independent Emmanuel Macron (En Marche!), for example, both advocate significantly more flexible labour markets. From the perspective of investors, this represents a binary event. The uncertainty surrounding the euro zone is balanced against the opportunity of a form of ‘Agenda 2010’ in France. While productivity gains in Germany are gradually declining, it is possible that in the case of political upheaval economic leadership in Europe could pass over to France.

Current polls suggest that Macron is the most likely candidate to face Le Pen of Le Front National in the second ballot on 7 May. With the additional support of Francois Bayrou, the 39 year-old former economics minister will appeal to a broad swathe of the French Public. In contrast to Fillon – and not only as a consequence of the ‘Penelope scandal’ – Macron is not considered part of the ‘old’ political establishment per se. Up to now, Macron’s election platform has been considerably more moderate than that of the Republicans, which in a second ballot would give him the prospect of votes from the left. Fillon’s policies include abolishing the wealth tax and the 35-hour week, while Macron has stated that he would reduce wealth taxation and push for more flexible working hours. In some respects, the Macron agenda is not unlike those of Scandinavian countries.

In our opinion, the prospects for a victory of Le Pen in a direct race against Macron are considerably less favourable than against Fillon, which was the expected scenario in December. Moreover, it remains to be seen to which extent Marine Le Pen would be able to carry out her proclaimed weakening of the EU. These plans are expected to be blocked by the majority in the National Assembly.    

With growing popularity in the polls for Macron and the negative sentiment in the bond markets, the risk-return profile for French government bonds can once again be rated as attractive. From the relative perspective against German Bunds, the risk spread appears, at this time, to be adequately pricing-in the uncertainty that surrounds the French presidential elections. In the second half of the year, uncertainties may well concern Germany and a possible political realignment.

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