(Bloomberg) – All polls show that French President Emmanuel Macron is likely to win a second term on Sunday. But from Citigroup Inc. to wealth manager Amundi SA, warnings are piling up that markets are underestimating the risk of a surprise.
Most read by Bloomberg
READ: Macron and Le Pen back high-stakes French debate
If nationalist Marine Le Pen angers the incumbent, European stocks are likely to fall on Monday, while French bonds would underperform German equities and the euro could even trade par with the dollar in the coming months, according to investors and strategists. The full ramifications would only become apparent after the general elections in June, when it will be clear whether she will have a majority to support her proposals to review free trade agreements and reintroduce border controls.
Macron leads Le Pen 55.7% to 44.3% and goes into the only debate on Wednesday night, a poll average shows. But the memories of 2016, when investors were stunned by the strength of populist sentiment surrounding Britain’s vote to leave the European Union and Donald Trump’s US election, are undiluted.
“It would be a terrible day for the markets,” said Eric Hassid, trader at Aurel BGC in Paris. “I still think Macron will win, but the opinion polls after the presidential debate will be crucial. It wouldn’t be the first time there’s been a surprise. We had the same thing with Brexit.”
Banks and fund managers recommend various strategies to hedge against a possible Le Pen victory. Citigroup, which puts Macron’s upside chance at 65%, recommended investors on Tuesday to sell eight-year French government bonds while buying the corresponding Austrian security. Amundi is “cautious” on European stocks and the euro, preferring stocks of high-quality US companies and cheap stocks instead, the company said last week.
The story goes on
READ: Trader’s Guide to the Euro Ahead of French Presidential Election
Stephane Monier, chief investment officer at asset manager Lombard Odier, is advising investors worried about a Le Pen win to trim their euro holdings in favor of the dollar.
Britain’s FTSE 100 index fell 5.6% in two days after the Brexit referendum, while the Stoxx 600 lost 11%.
A Le Pen win would arguably be an even bigger shock to investors, as the polls show Macron a bigger lead than in the 2016 Remain election. And French pollsters have a good track record of polling ahead of the 2017 election and in this year’s first ballot very much in line with the results.
There would be a “Black Monday” in stock markets if Le Pen wins, with the Stoxx 600 likely down 6% and France’s CAC 40 index down even more, said Ludovic Labal, manager of the Strategic Europe Quality Fund at Eric Sturdza Investments .
In a note on Wednesday, strategists at Barclays Plc, led by Emmanuel Cau, wrote that if Le Pen wins, they expect equity markets to fall by at least 5%, but see no reason to panic at this time. Oddo BHF strategist Sylvain Goyon put the likelihood of a Le Pen victory at no more than five years ago, but such an event would be particularly unfortunate for financial stocks, while the euro would likely fall below parity against the dollar.
On the credit side, Barclays strategists warned that corporate bond investors should not be too indifferent to the possibility of Le Pen becoming the next president, saying risks are on the downside.
“It would only take one survey pointing to tighter racing to trigger underperformance in French credit,” Barclays analysts wrote. “Given the lack of a risk premium on these loans, we remain cautious.”
While Le Pen is no longer in favor of leaving the European Union, he is calling for a referendum to revise the constitution to put French law above EU rules. It also wants to restore permanent border controls in the Schengen area, which would go against the bloc’s law, and would seek to reduce financial allocations to the EU.
These measures would reverse Macron’s quest for greater European integration, weighing on bonds from weaker EU countries like Italy, Citigroup said. The outcome would also undermine other pro-EU leaders like Italy’s Mario Draghi, said Frederik Ducrozet, strategist at Pictet Wealth Management.
“It would be a huge psychological shock for people of my generation and older,” said the 41-year-old Ducrozet, who voted in 2002 when Jacques Chirac defeated Le Pen’s father in the second round. “Macron is probably the most pro-European and experienced leader in Europe – so what would that mean for Draghi? What would that mean for the rest of Europe?”
A win for Le Pen could see the spread between Italian and German 10-year bond yields widen to almost 250 basis points from 164 basis points at the close on Tuesday, he said. In the longer term, there is also “a lot of complacency” about the level at which the European Central Bank would intervene to calm markets, Ducrozet added.
For now, however, as Macron’s lead in the polls has widened, the spread between French 10-year government bond yields and equivalent German bonds has narrowed to 47 basis points from 55 basis points before the first round on April 10. Vincent Juvyns, global market strategist at JPMorgan Asset Management, said the spread could rise to more than 80 basis points in the event of a Le Pen victory.
Viraj Patel, macro strategist at Vanda Research, recommends buying credit default swaps on Italian government bonds as a hedge against the risk of more post-election fragmentation in the euro area. He also sees a possible Le Pen win as a trigger for a “complete capitulation” by those betting on a stronger euro.
“A Le Pen victory would give us the conviction that we need to call for euro-dollar parity, but that might be a three- to six-month development rather than a one-day knee-jerk,” he said.
Given that Le Pen would need to win a parliamentary majority in June to fully implement her policy, FX traders should be able to focus on other drivers for the euro, such as monetary tightening, Lee Hardman said Forex analyst at MUFG Bank.
“The market might initially overreact to Le Pen’s surprise win, but the reality might not be as bad as initially feared,” he said, adding that the euro could weaken by 3% to 5% after the first win. “It’s going to be pretty limited in terms of politics that she can really pursue.”
Regardless of the outcome of Sunday’s vote, market volatility could continue into June’s general election.
(Updates with Barclays credit comment in eleventh paragraph)
Most Read by Bloomberg Businessweek
©2022 Bloomberg LP