Investors have exuded sangfroid about the French presidential election, largely ignoring the risk of Marine Le Pen’s far-right Front National riding on the populist wave that propelled Brexiters and Donald Trump to victory.
Such market composure always seemed too good to be true, and this week it showed signs of cracking.
As the first round of election on April 23 nears, the cost of insuring against a volatile swing in the euro has jumped. One-month options contracts on the euro-dollar pair have risen to their highest level since the fortnight before the Brexit vote.
The tendency ahead of a serious political risk is to see “a lot more hedging activity in the two preceding weeks”, said Alberto Gallo, head of macro strategies at Algebris Investments. It was the case in the run-up to Brexit and the US election, and it began on Monday, less than a fortnight before the first round vote.
While the French election was always going to be the standout event of the second quarter, April began with opinion polls throwing up one election outcome investors had not considered.
This was the prospect that Ms Le Pen could end up in a second round run-off against far-left candidate Jean-Luc Mélenchon. A seasoned politician with a contempt for the EU and its currency to match that of the FN leader, and a policy to impose a 100 per cent tax rate on top earners, he has gained altitude in opinion polls.
At this juncture, the polls continue to point to a second round run-off between Ms Le Pen and the centrist candidate Emmanuel Macron, and for Mr Macron to then prevail.
Still, as Nomura forex strategist Jordan Rochester pointed out: “Just because the polls have been stable for Mr Macron and Ms Le Pen for some time we would not assume it will be the same for the last few weeks.”
Mr Mélenchon’s surge underlines the fluctuating mood of the French electorate. Polls also suggest that Mr Macron’s support is soft. “The Le Pen/Mélenchon market uncertainty is rising,” said Mr Rochester.
There is, however, considerably more volatility in the euro options market than in spot currency trading. Even though the euro has been declining in recent weeks, the fall has been relatively contained.
The euro has sagged 2.3 per cent against the dollar in the past 11 days, and 5 per cent against the yen in three weeks, a renowned haven currency and thus a proxy of French election risk. Selling of French bonds illustrates further evidence of the market’s election jitters. French 10-year yields have risen to a six-week peak over their German equivalent.
“The euro has been pretty resilient,” said Mr Gallo. Indeed, eurozone data make it tempting for strategists to look through the French elections to a period when the euro can rally, rates and inflation can go higher and European equities can bounce.
According to Patrick Zweifel, chief economist at Pictet Asset Management, if there is investor risk from the election it points in the direction of a strong market rebound should France choose an establishment candidate such as Mr Macron or the centre-right’s François Fillon.
“That would be extremely positive,” he said, with one eye on strong eurozone growth and another on the election of either of these candidates setting France on the path of structural reform.
“Is the market going to acknowledge that by the end of May? Probably not,” said Mr Zweifel. “But the risk is more tilted to the upside than the downside.”
There is the danger that the French election, and concern about the popularity of the anti-EU Five Star Movement in Italy, will distract investor attention from underlying risks elsewhere.
Market fears are too high in Europe and not high enough in the UK and the US, said Mr Gallo — perhaps a reflection of the Anglo-American nature of capital, he suggests.
“The market’s favourite hobby is to worry about France and Italy. Yet there is no strategy for a post-Brexit economy and there is a risk that Trump’s domestic agenda may be further delayed,” he said.
According to Willem Verhagen, senior economist at the Dutch-based NN Investment Partners, Brexit was “a one-off event with no comparable benchmark”, while Mr Trump’s victory was the result of the peculiarities of the electoral college, whereas the French election is a “more straightforward” political risk.
Although Ms le Pen is polling well, the Front National has been around for many years, “so that makes me feel there is less risk from a polling error than with Brexit or the US election”.
There is another difference. Since the French election is spread over two rounds and two weeks, investors will have the opportunity to reassess their options when the campaign narrows to the second round run-off.
A better than expected first-round showing by Ms Le Pen should increase hedging activity when markets reopen on April 24. “But if she does not, then it becomes very expensive to hold a hedge for a low probability outcome,” said Mr Gallo.
The French election will have investors poring over polling numbers for a good few weeks yet.