France: The great Le Pen scare – Danske Bank

According to the analysts at Danske Bank, although data from the euro area last week painted an upbeat picture, with strong manufacturing PMIs and German ifo readings, French government bonds and the EUR remain under pressure, as investors’ remain focused on the upcoming French presidential election and the risk of a Marine Le Pen win.

Key Quotes

“According to recent polls, it is still most likely that either the independent candidate Emmanuel Macron or the Republican François Fillon will become France's next president (see chart top right). However, there is a significant risk the Front National (FN) candidate Marine Le Pen, who has threatened that France will leave the EU and the euro if she is elected, will win the presidential election. Nevertheless, even if Le Pen is elected, the road to an actual ‘Frexit’ is long. Whether Le Pen can or will actually hold an EU/euro referendum will depend largely on FN’s performance in parliamentary elections in June and support from her chosen prime minister. In our view, it is still questionable whether the public would vote in favour of leaving the EU/euro in such a referendum.”

“What if? Risk-off and weaker euro if Le Pen is elected president

In terms of short-term market reactions following a Le Pen win (not a ‘Frexit’, which would have far more severe market implications), we expect the ECB to use its existing QE flexibility to support countries vulnerable to financial spillover, especially in the periphery, whereas support for France could be limited. We expect to see a knee-jerk market reaction with a broad-based risk-off move triggering EUR periphery spread widening relative to France, a Bund rally and curve flattening, although the exact spread impact would depend on the ECB response. For the Nordic markets specifically, we are likely to see safe-haven inflows, with NGB/SGB/DGB ASW spreads widening.”

“In FX markets, we would expect the EUR to weaken versus other major currencies and EUR/USD to settle 2-3 figures lower. In our view, the GBP could be one of the top performers if Le Pen wins the election, due to an increase in the EUR risk premium and a decline in the Brexit risk premium priced on GBP. However, we remain cautiously bullish on SEK and NOK versus EUR. In the case of a Le Pen win, Nordic currencies such as the SEK and NOK could even strengthen further to the EUR driven by safe-haven inflows. Should the SEK strengthen too rapidly, we could see additional easing measures from the Riksbank (such as lowering the rate path or postponing future rate hikes and an end to QE in July, as we currently expect) but we do not expect a Le Pen win to trigger easier monetary policy in Norway, as Norges Bank has shifted its short-term mandate focus towards financial stability. The reaction in EUR/DKK spot and forward markets, on the other hand, should be more muted as Danmark’s Nationalbank would use FX interventions to cap EUR/DKK downside around 7.4340, although in our view the bar for further rate cuts is very high.”

“The medium-term move in equity markets on a Le Pen win would depend on whether FN is able to secure a majority in parliamentary elections in June.”