Considering what is at stake in the French Election, “the overall market response has so far been remarkably orderly and, overall, quite muted” writes Francesco Garzarelli
Co-Head of Global Macro & Markets Research in the bank’s Top of Mind Global Macro Research magazine March issue.
Market Response To French Election Risk Is Too Muted
Gerzarelli believes there is little evidence (so far) of systemic risk based on market pricing ahead of the French presidential elections. Considering what is at risk, this is surprised. One possible reason for such a nuanced reaction from the markets is the unexpected outcome of both the UK and US referendum and election. This time around it seems, investors are happy to wait and see the final outcome.
However, if the outcome is negative Gerzarelli believes the markets could experience a short sharp sell-off as unlike the UK and US events, a Marine Le Pen victory would be a significant blow to the EU’s monetary union:
“Should Le Pen win against the odds, expectations of reintroduction of national currencies would rise, market dislocations could potentially emerge, primarily in EMU sovereign bonds, and bank and international spillovers would likely follow.”
French government bonds are some of the only assets showing anxiety. Gerzarelli points out the return correlation between OATs and German Bund yields has declined to the low 70% range, compared to an average of around 90% since the start of the ECB’s quantitative easing (QE). At the same time, Goldman’s analysis isolating the “rate shocks” driving EMU bond markets suggests that France displaced Italy this year as the dominant force pulling EMU yields higher, reflecting a build-up of risk premium ahead of the elections. Meanwhile, riskier Italy, Spain, and Portugal government bonds are trading at a higher positive correlation to Germany than the average of the past two years.
This muted response could have something to do with the fact that European economic growth is starting to pick up and the outlook for the region’s economy is certainly much brighter than it was this time last year. Against this backdrop, despite the possible risks posed by Le Pen, Gerzarelli and team like the look of cyclical stocks and corporate bond returns. With the yield curve steepening, the environment for bank lending is also improving, which could help out financials.