As France votes, are markets napping?

On Sunday, France heads to the election booth for the second time in a month.

After casting their first-round ballots on 10 April, voters will face a straight choice in the run-off between Emmanuel Macron and Marine Le Pen. The result’s implications for investors, however, are anything but straightforward.

Polls have consistently pointed to a Macron victory. One recent survey put his lead as wide as 12 per cent, and betting markets now give Le Pen a less than one in 11 chance of edging the ballot. But the gap has been as low as 3 per cent – within the margin of error – and voters’ intentions appear less clear this time around.

That means the result is set to be more finely poised than the last time the two candidates faced off five years ago, when Macron took 66 per cent of the vote.

Are investors prepared for an upset? What would a Le Pen win mean for equity, debt, and currency markets? And even if Macron proves the polling firms right, what does the race’s tightness say tell us about the outlook for investors in France and the eurozone?

Fait accompli?

In 2017, the world was glued to the French presidential election. Following shock political results in the UK and US in the year before, and the apparently unstoppable rise of anti-establishment candidates, that was hardly a surprise.

This time around, financial and general news coverage has been marked by its absence. With the agenda dominated by Russia’s aggression in Ukraine, that is perhaps understandable. But any disinterest or assumption that Sunday marks a re-run of the 2017 ballot arguably underplays the stakes for France and Europe.

Although the competitors’ faces are the same, their platforms have changed considerably. This is especially true of Le Pen, whose push to “detoxify” her party – which was known as the National Front in 2017, but now calls itself National Rally – has helped efforts to appeal to individuals suffering from a cost-of-living crisis.

To many working-class French voters, the fault of this crisis lies with Macron, who has remained unpopular for most of his time in office. Seen by his critics – and even some of his voters – as arrogant and out of touch with the concerns of ordinary French people, he went into the first round with an approval rating of just 43 per cent. While much improved from a low of 24 per cent at the end of 2018, when opposition to fuel taxes and economic inequality sparked the gilets jaunes protests, enthusiasm for the incumbent is thin.

Macron’s reputation as the président des riches (president of the rich) among supporters of Jean-Luc Mélenchon, the socialist candidate who came in a close third in the first round, is likely to cost him left-wing voters who would normally be opposed to Le Pen. This means the result could hinge on the 27 per cent of voters who either abstained or spoiled their ballots in the first round of the election.

In short, Macron’s re-election is far from a fait accompli. Despite this, relative calm has broken out on key equity markets in the past weeks. The CAC 40 benchmark index of Paris-listed blue chips is up 1.2 per cent since 8 April, the last trading day before the first round – just ahead of the Euro Stoxx 50.

Meanwhile, the yield on 10-year French sovereign debt has expanded 60 basis points to 1.41 per cent over the past month, although this is broadly in step with other developed economies and down to gnawing inflation concerns rather than political calculation. The spread over less-risky German bonds is also thinner than it was ahead of the 2017 vote. At $1.09, the euro is also more highly valued.

Un risque

All of this suggests a Le Pen victory would come as a huge shock.

Faced with a pro-business continuity candidate deeply invested in greater European integration on the one hand, and an unknown populist with protectionist and anti-EU views on the other, commentators have typically framed Le Pen as a source of risk to markets.

This isn’t a political judgement, per se, even if the National Rally candidate counts few open allies in the worlds of asset management and finance.

Talk of market risk has also continued despite a softening in rhetoric since the 2017 election, when Le Pen campaigned for France to leave the European Union and quit the euro. At best, analysts believe her election would lead to a “noisy stalemate” in Europe. However, a manifesto which plans to discriminate against foreigners in favour of French citizens and hold a referendum on putting French law above EU law are seen by many as a prelude to Frexit.

A more cosy stance towards Russia than her predecessor could also change the logic for European sanctions, trade and energy prices.

“If France elects an inexperienced and populist president – who has in the past showed sympathies for Russian president Vladimir Putin – France and the EU would face a major upset almost comparable to the surprise win of Donald Trump in the 2016 US elections,” wrote Berenberg economists Kallum Pickering and Holger Schmieding in a recent note to clients.

As such, investors should expect a Le Pen victory to impact all eurozone-linked investments.

The first and clearest sign of this is likely to be felt in forex markets. The euro would likely drop sharply against major currencies, as the prospects for the bloc’s political and monetary workability are re-priced. In turn, this could force companies with significant sales in Europe to take significant exchange adjustments or impairments.

Bond investors, faced with fresh concerns over the bloc’s unity, would need to recalibrate. Le Pen, who argued in 2015 that the “euro and austerity are indissolubly linked”, believes that the European Union’s role in economic policy making should be devolved to its members. Impacts would likely be uneven but could prove more dramatic in the markets for more indebted nations than France, such as Italy and Greece.

A Le Pen victory might also “lead to higher rates, but due to increased uncertainty, a shock to confidence and growing deficits” reckons Kevin Thozet of at French asset management Carmignac.

Investors shouldn’t discount a fiscal boost and consumer boost in the short term, given the broadly redistributive flavour of Le Pen’s fiscal and social policies. Signature pledges include a cut to VAT paid on energy from 20 to 5.5 per cent, tax cuts for SMEs and to reduce the pensionable age from 62 to 60 for those who started worked before 20.

Citi puts the overall cost of her proposals at between €70bn and €120bn a year – equal to 2.6 to 4.5 per cent of national output – with the wide range partly due to her ability to cut €18bn from welfare payments to foreign citizens. This compares to €44bn to €57bn per year from the more fiscally conservative Macron, who plans to reduce France’s budget deficit to 3 per cent of GDP by 2027 compared to a forecast 5 per cent this year.

L’Europe, l’impasse

There is little certainty such policies will ever make the jump from campaign leaflets to legislation. Even if she springs a surprise victory, commentators believe Le Pen would struggle to win an outright majority after parliamentary elections in June. She could find it almost impossible to govern.

A similar impasse might await Macron, whose plans for economic and regulatory reform have failed to win him much democratic support.

For investors, either outcome is unlikely to boost the attractiveness of French or European equities – despite the high proportion of quality businesses on the continent. Political logjams may not dictate equity returns, but they don’t provide a great backdrop for multinationals’ investment decisions. Simply put, it is hard to secure political majorities in Europe for the sort of pro-business policies necessary to unleash US-style red-blooded capitalism.

While Europe has looked more politically united and determined since Russia's invasion of 24 February than at any point in recent history, a Le Pen victory would raise big questions about the continent’s orientation in a rapidly reconfiguring geopolitical order. Whatever happens, her much-improved standing with the French electorate serves as a reminder that inflation concerns are starting to dominate voter decision-making.