How to trade the French election - Nomura

Analysts at Nomura explain that while polling for the French election provides comfort to markets, the possibility of a surprise Marine Le Pen victory cannot be ignored and therefore, they thinks it is prudent to take a look at how the night will unfold.

Key Quotes

“We have looked at how EUR and OATs will trade over the next month, the lessons from previous elections and how exit polling will work on the night.”

“What you need to know about the French elections’ first round (23 April): Polls have both underestimated and overestimated Marine Le Pen’s support over the years. Exit polls will be released at 7pm (BST), just one hour before the Sydney FX market opens on Sunday 24 April (local time), with the result known with a high level of confidence by 9pm to 11pm. 2012’s exit polls uniformly overestimated the FN’s support (+0.6% to 2.1%). If Marine Le Pen’s support is higher than 30% we expect financial markets to be more concerned ahead of the second round. The market currently expects Emmanuel Macron and Ms Le Pen to make the final runoff, but polls may shift considerably in the final two weeks. So there is a chance of a scenario, where one of the two favourites does not make it into the final runoff. This could be the déjà vu moment, as it would be a rerun of 2002. After the first round, endorsements for the two candidates from the remaining candidates may be market moving if they are for Ms Le Pen.” 

“Second Round (7 May): The second round follows a similar timeline to that of the first round with release times. During the two-week campaign, polls have previously tightened, but then the favourite tends to win. However, if turnout is as low as some polls suggest, 65% in some cases, then a Le Pen victory is not impossible. If Ms Le Pen wins we would expect EUR/USD to test parity, potentially falling to 0.97 and 10yr OATs to sell off by 30bp. Our base case is that Mr Macron wins, both EUR and OATs rally, but the difference is that we would expect the EUR rally to continue by year-end to 1.15, but we would eventually fade the rally in OATs as tighter policy from the ECB is on the way.”

“It is not just about the French election: The French election is not the only event in the near future, with the ECB and the FOMC meetings both event risks worth considering. But typically the market tends to focus on these binary risk events, even if they are deemed to be “unlikely.” So far EUR has followed the script and traded lower in recent weeks, but this has been owing to the ECB’s less hawkish comments rather than French election risk.”

“Trades into and beyond the event risk: One of our highest convictions in the final weeks of the election is hedging flows are likely to weigh on EUR and push election-dated vols higher before a selloff in the days prior. We expect a Macron victory and expect EUR to have a relief rally. EUR would trade materially higher beyond the knee-jerk reaction after the event risk with the ECB moving towards tighter policy over the year, so we target EUR/USD at 1.15 by year-end. On the rates side, on a Macron win the overarching theme in markets will likely be an ECB normalisation. We continue to hold tighter 2yr schatz swap spreads and Eonia curve steepeners. We maintain a short bias on 30yr OATs vs. 30yr Bunds and SPGBs.”