Demystifying the 'Le Pen effect' — #SaxoStrats
- Fears Le Pen will become president based on misunderstanding of political system
- Next president faces battle to curb spending after over-optimistic forecasts
- French/German 10-year bonds yield spread indicates scale of problem
- Japanese investors exiting French for German bonds in their droves
The Le Pen effect — some recoil, some embrace. Photo: Shutterstock
By Christopher Dembik
The French 10-year yields spread to German bunds remains quite high at 71 basis points this morning, close to its level of November 2012. A few months ago, it was only around 20 bps.
The most frequently cited explanation for the higher spread is the “Le Pen effect”, which corresponds to foreign investors’ fear that Marine Le Pen, the leader of the Front National, could be elected president in May.
As a French citizen, I consider this fear is quite overestimated and is mostly linked to ignorance of how the French political system works. Plenty of studies taking into account the last cantonal and regional elections conclude that voters usually adopt the most appropriate behaviour to avoid the victory of candidates or lists supported by the Front National.
Under these circumstances, it is highly unlikely that Le Pen will be able to gain enough support in the second round of the presidential election to cross the 50% threshold (at least in 2017).
Actually, there are three more important dynamics to take into consideration when it comes to the French spread and explain that borrowing costs for France will keep increasing, no matter who will be the next president:
- The comeback of inflation at the global level, linked to higher commodity prices (+9% in January 2017 compared to January 2016) and China’s exit from deflation since September 2016
- The divergent economic situation between France and Germany. In some respect, an increasing French spread can be considered a return to a more normal level.
- Key point which is not mentioned enough: a greater selectivity of foreign investors which is not really linked to the upcoming French presidential election. Since November 2016, Japanese investors have massively favoured bunds whereas they have preferred OATs throughout most of 2016 (graph below).
A massive preference for German bunds from Japanese investors
Source: Macrobond, Saxo Bank
As a matter of fact, the next government will have no other choice than amending the 2017 finance law which forecasts a level of borrowing cost way too optimistic at 0.9%. Further spending cuts will probably include lower financial transfers to local authorities (which represent around a total of €100 billion/year).
— Edited by Martin O'Rourke
Christopher Dembik is an economist at Saxo Bank's Paris office