President Le Pen: low risk, but strong shock

Some time ago it became clear that in 2017 the most important political risks for the global financial markets will be the possible election of a President marine Le Pen (Marine Le Pen) in the second round of the French elections held on may 7. Last week this risk has attracted even more attention when a small change in its chances of victory in the presidential elections has caused a sudden widening of spreads in Eurozone bonds: the yield spread between bonds of France and Germany accounted for almost half of the average level observed during the crisis of 2011.


Investors have grown accustomed to political turmoil, which are based on variations in the direction of populism, particularly in the United Kingdom and the United States last year. This experience has led some investors to conclude that the third unexpected victory of populism is likely to occur in France, because “to believe the polls any longer”. However, they usually add that “Brakcet and trump has not led to disaster in the markets, and Le Pen is also unlikely to be able to do it.”


But both these conclusions are incorrect. The probability of election of the President Le Pen is much lower than the probability of Breccia and the election of the President of trump last year, however, the consequences of its victory can be much more serious. This time the “experts” do not exaggerate the seriousness of the consequences for the markets.


Why marine Le Pen is unlikely to win the presidential election in France, given that, according to many polls, she is one of the leaders of the first round? The answer is obvious. Although in the first round she will be able, with a small advantage to win over several of his opponents in the second round the voters opposed to it, will unite, causing it to lose any other potential candidate.


Although about a quarter of the French electorate’s preference for Le Pen, approximately 60-65% of voters are ready to vote in the second round for any other candidate but her. In the electoral system in France, those 35-40%, it could eventually gain guarantee its defeat.


If it’s so obvious, why on Monday, the markets started to panic? The most likely cause could be problems in the election campaign of former Prime Minister françois Fillon (Francois Fillon), who has lost the status of leader of the race, faced with accusations of embezzlement of public funds. If he continues on this race as the weaker candidate, the chances of Le Pen to win rise slightly.


Some experts point to another risk. Currently in France there are two relatively radical candidate of the left wing: Benoit Amon (Benoit Hamon), and Jean-Luc Mélenchon (Jean-Luc Melenchon), which according to polls, gaining about 15% and 11%, respectively. Although they’ll take some votes for themselves, they are unlikely to reach the second round.


However, if one of them will drop out of the race in favor of the second, perhaps one of them will be able to win over Mr. Fillon and centre-left Emmanuel Macron (Emmanuel Macron), which is currently the favorite to advance to the second round of voting. In this case, Ms. Le Pen will have a higher chance to win because she will fight with an opponent of more radical persuasion. Such a scenario is unlikely, but not impossible.


The only outcome which will be a real shock for the global markets, is a victory for Le Pen. Analyst Matthew Walterspiel (Matthieu Walterspiler) believes that the probability of such a development is only 10-15%. This is a much lower probability compared with the probability of winning supporters of Breccia and Donald trump last year. Therefore, the shock will be much stronger.


Let’s try to assume that marine Le Pen still won the presidential election. Will it be similar to Prexit — that is, an event which is feared and which has not had any significant impact on the markets (with the exception of the pound sterling)? No, I think.


Marine Le Pen will assume the duties of the President during the week that is likely to give the National front the opportunity to obtain a majority of seats in the National Assembly elections on 18 June. She will need it most, to organize a referendum on withdrawal of France from the European Union and the Eurozone, perhaps by the autumn.


The results of the surveys have traditionally indicated that France will vote 55% to 45% to remain part of the EU, however in such political circumstances, who knows what could happen? Markets, obviously, will have to rely on relatively high risk of exit of France from the Eurozone and the risk that its example will be followed by other countries.


This fear will trigger a significant outflow of capital from France, which will weaken the national currency. Although theoretically the ECB can defend the Euro, allowing the TARGET2 imbalances increase dramatically, it is unclear whether Germany is ready to go at it.


In the case of several countries from the Eurozone, these imbalances can turn into huge loans from the Central Bank of Germany and the European monetary system — a loans that leaving the country will not be able to fully recover. Political pressure within Germany and calls to return to the Deutsche mark strengthens.


Le Pen has a more optimistic view, saying that France may leave the Eurozone without any problems. In a different political universe that should be possible. But what must be this universe?


France can return to Frank, who then have to survive the devaluation, as happened with sterling last year. The Central Bank of France may point inflation target and asked to monitor rates in order to achieve it.


Euro may remain a hard currency, which will use a smaller number of countries rallied around Germany, or transformed into “new European currency unit” that will bring us back to the days when the single currency did not exist. Financial contracts around the world, denominated in Euro, is not affected.


However, all of this will require significant planning and cooperation with other members of the Eurozone. In addition, the President Le Pen will have to stick with the traditional rational approach to monetary and fiscal policy. At the moment she is more willing to increase government deficits and monetization of debt — such a plan would cause a panic in the markets and a sharp rise in inflation in France.


In contrast to the United Kingdom last year, France has established macroeconomic policy frameworks, on which to rely. So now one can hardly hope that France is able somehow to leave the Eurozone without unnecessary shocks, following the example of the United Kingdom after the vote on Brexia.


France has experienced something similar. I remember very well one Sunday night in 1981 when he was elected President Mitterrand. Then it seemed that France put an end to the European dream and declared its independence from the global market economy.


After two years of political struggle Mitterrand abandoned his election platform and embarked on the path of European integration. However, during these two years, markets have experienced a nightmare.

Gavin Davies is Chairman of Fulcrum Asset Management and co-founder of Prisma Capital Partners. He was head of global Economics at Goldman Sachs from 1987 to 2001 and was Chairman of the Board of Trustees of the BBC from 2001 to 2004. He also held the position of Advisor to the Prime Minister on economic policy, was an invited consultant to the British Treasury and a Professor at the London school of Economics.