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Article / 21 April 2017 at 10:30 GMT

Europe Divided: Markets tense, but not panicking... — #SaxoStrats

Head of Macro Analysis / Saxo Bank
France
  • Investors tense ahead of French election, but volatility short of 2017 high
  • Anglo-American consensus may overplay Le Pen risk due to Trump/Brexit
  • Macron/Fillon second round would boost CAC 40, banking shares Monday
  • Read more on our dedicated Europe divided page

By Christopher Dembik

The market is tense but it is not panicking. Between April 1 and today, the VCAC (which measures the volatility of France's benchmark CAC 40 equities index) moved up from 16% to 27% but still remains lower than its 2017 high (40% at the start of February).

Furthermore, the Franco-German spread is admittedly higher than in previous months but it has stabilised in recent weeks at around 70 basis points.

Volatility

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Source: Saxo Bank 

This is a sign that France continues to be very attractive and that confidence remains high – yesterday, for instance, the country issued three-year bonds and obtained negative interest rates.

Historically speaking, the presidential election has had little effect on the CAC 40. The only exception was in 1981 when the Paris bourse fell by almost 20% in the 30 days following the first round because investors feared that "Soviet tanks were going to roll down the Champs-Elysées"

Given the low probability of a Marine Le Pen victory due to the anti-Front National stance of the mainstream parties, such a dip is unlikely to happen again this year.

A very clear distinction can be drawn between the Anglo-American assessment of France's political situation and that of other foreign investors. The former, due in many cases to a misunderstanding of the French electoral system (ignorance of the two-round system and/or the anti-Front National policy of mainstream parties) and as a result of the Brexit/Trump shock, see the French election as a very high-risk vote. 

Conversely, other foreign investors are more confident about the outcome and are increasingly assessing the risk as over-stated.

Marine Le Pen
Has too much been made of the "Le Pen threat"? Photo: Shutterstock

The "Le Pen effect" – namely the FN candidate getting through to the second round – has already been priced in. In order for the market to react strongly when it opens Monday morning, Le Pen must either obtain a much higher than anticipated share of the vote (i.e., above 25%) or fail to get through (which would mean a Macron/Fillon second round). 

In the first case, risk-aversion would drive a move to safe-havens and a drop in banking stocks. The recent stability of the euro (as a result of the Eurozone's current account surplus, the stabilisation of monetary policy, the return to inflation etc.) leads one to believe that the currency is not particularly exposed as far as French political risks go. 

In the second case, a final vote pitting the two parties of government against each other would constitute a return to business-as-usual in terms of the electoral process and also a rejection of populism, which would definitely boost the CAC 40 the following Monday (and push up banking stocks in particular). 

Such a fillip could in turn enable the Paris index to catch up in relation to the other European bourses with regard to its poor performance since the start of the year.

As a result of his fragile electoral base, it seems unlikely that the leftist Jean-Luc Mélenchon will qualify for the second round, and the dark (for markets) scenario of a Mélenchon/Le Pen second round appears similarly improbable. 

Ultimately, Mélenchon is not seen as credible by the markets or by the opinion pollsters.  

French election
Will French voters shock markets Sunday? Photo: Shutterstock

— Edited by Michael McKenna

Christopher Dembik is head of macro analysis at Saxo Bank
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