Friday 28 July 2017

'Frexit' by EU founders at stake as French go to polls

As the battle to be president hots up, victory for Marine Le Pen would cause crisis in markets

'Marine Le Pen is expected to win the first round of the French presidential elections but be defeated by Macron or Fillon in the second vote' Photo: Reuters
'Marine Le Pen is expected to win the first round of the French presidential elections but be defeated by Macron or Fillon in the second vote' Photo: Reuters

Zak Kacem

Next Sunday the French electorate heads to the polls for the first of two expected rounds to elect a successor to François Hollande, France's socialist President. A great deal hangs in the balance, not least the potential for a 'Frexit' that would be far more devastating for the EU than Brexit or the recent financial crisis.

After a period of considerable anti-Euro sentiment, market jitters appear to have eased following the election of a pro-European government in the Netherlands. However, the rise of National Front candidate Marine Le Pen and surprise votes in favour of Brexit and Trump show that markets are far from infallible and that votes can have very far-reaching and unintended consequences.

In theory, if one of the candidates gets more than 50pc of the vote in round one he or she wins - but that's never happened. It's more likely no candidate secures a majority and round two kicks off a fortnight later between the two candidates with the most votes.

The main contenders

On the far right, Marine Le Pen, daughter of National Front (NF) founder Jean-Marie Le Pen, would like to "make France great again". Le Pen is a hard-liner on immigration and protectionism and is not adverse, if necessary, to a Frexit.

On the centre right, François Fillon is a liberal conservative. Fillon is the most experienced candidate and was tipped to win, but has been plagued by scandal. He scores third in polls behind Le Pen and Macron with 19pc of vote intention in the first round. In the centre, 39-year-old Emmanuel Macron is running as a liberal independent candidate. A former Socialist Party member, he is gathering a lot of momentum and the latest polls show he is the frontrunner along with Le Pen on 23.5pc each. On the centre left, socialist Benoît Hamon is struggling to keep up with the other four main contenders.

On the far left, Jean-Luc Mélenchon, has been gaining ground. He is only two points below Fillon on 17pc and could be a dark horse in the race.

Polls and market view

Polls have consistently suggested that Le Pen will win the first round, but will lose the second round to Macron or Fillon. The tensions in European markets in the first quarter provided a small taste of what a Le Pen victory would feel like. Nevertheless, a Le Pen victory isn't priced [yet] in any market. If Le Pen wins, and speculation mounts on the potential for France to leave the euro, it is easy to see how a real crisis could emerge in European fixed income and stock markets. It would be virtually impossible to quarantine stresses to France and undoubtedly, Irish and other peripheral markets, would be affected and doubts about the sustainability of the euro would dominate.

Can Le Pen become President?

For over 40 years, centre right and left-wing political parties captured the majority of the vote, which made it virtually impossible for the NF to win a presidential race. This year could be different. The incumbent centre-left socialists are unpopular for failing to deliver on promises whilst the centre-right's Fillon is mired in scandal and his reformist economic agenda is considered by many as an end to the French social model. All the while the NF has been working hard to improve its image and broaden its appeal. The National Front believes it has "the same ideas as the people". But do people have the same ideas as the National Front? Arguably there has been some alignment of positioning.

Firstly, there is general discontent regarding security, immigration, terrorism and, most importantly, jobs. Secondly, many voters are economic casualties of globalisation. Lots of manufacturers, farmers and other small businesses see themselves as victims of the single market and globalisation. These issues are to the forefront of public debate. As a consequence, the French, so long seen as the ultimate Europhiles are beginning to use the 'F-word'.

Frexit: a low probability-high impact event

Unlike the UK, France is a founding member and a major pillar of the EU. Frexit would, in all likelihood, mean the end of the European project. In other words, even if Le Pen wins, Frexit should still be a relatively low probability. Yet as France is a key member of the bloc, the risks are so high that if it did materialise it would undoubtedly cause consternation within the EU. Leaving the euro would mean the country would face higher financing costs, potentially higher inflation and higher interest rates. These considerations might sound remote and abstract, but if you tell someone that returning to the franc would mean their money, savings and wages could be worth 15pc or 20pc less than its current value; chances are that they will want to stick with the Euro.

Second shall be first

The key to the French election is whoever comes out top in round one between Macron and Fillon. Whoever wins that particular duel will probably beat Le Pen comfortably in round two. Both are committed Europeans and economic reformers. Their differences lie in their social policies, but I believe a victory for either will be well received by the markets, which can then park the issue of the French Presidency for another five years and move its attention to September's German general election.

Zak Kacem is a French-Moroccan national and a portfolio manager in Davy Private Clients. Views expressed reflect the personal views of the author and not necessarily those of Davy. Davy Private Clients is a division of J&E Davy

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