Money managers are selling bonds of weaker European economies ahead of the first round of the French election on Sunday
By Mike Bird and Christopher Whittall
The Wall Street Journal
April 19, 2017 2:30 a.m. ET
With the start of the French election just days away, investors are contemplating their nightmare scenario: a choice between far-left and far-right candidates.
In recent days, a surge in opinion polls has placed Jean-Luc Mélenchon, a left-wing firebrand who promises higher wages and fewer working hours, as a potential candidate to move past this Sunday’s first round of voting. That could set up a second-round vote in May 7 with Marine Le Pen, an economic nationalist who wants to pull France out of the euro.
Most analysts still expect a mainstream candidate to make it through to the second round and eventually clinch the presidency. But Mr. Mélenchon’s sudden rise has spooked investors just five days before voting kicks off.
A runoff between Ms. Le Pen and Mr. Mélenchon “would be a disaster for France…[and] a disaster for Europe,” said Patrick Zweifel, chief economist at Pictet Asset Management.
Vive la fist
Under that scenario, investors would dump the debt of France and of weaker European economies and send the euro sharply lower, analysts say.
Investors recently have been selling French stocks and bonds, and the cost of insurance against a sharp fall in the euro, as measured by so-called one-month risk reversals, hit levels seen at the height of the continent’s sovereign-debt crisis in 2011.
On Tuesday, the spread between French and German 10-year government-bond yields, the most popular measure of election risk, widened to 0.73 percentage point. In mid-March, French debt was yielding 0.57 percentage point more than German debt. As recently as last September, yields were just 0.22 percentage point apart.
For months, investors prepared for a runoff that pitted Ms. Le Pen against a candidate from the political mainstream, either François Fillon, a center-right former prime minister, or Emmanuel Macron, a former economy minister.
Analysts believe that either would beat Ms. Le Pen in a second round, as voters of different political stripes coalesced around a candidate that wasn’t the National Front leader.
But the rise of Mr. Mélenchon has scrambled those calculations. He moved into third place in several polls, passing Mr. Fillon.
“The problem is we have a four-horse race where statistically it is a bit too close to call,” said Mark Dowding, co-head of investment-grade debt at BlueBay Asset Management. “We’re just sitting on our hands waiting, because we aren’t able to discount a low-probability but high-impact event.”
The prospect of a victory for Ms. Le Pen, however distant, has long spooked markets. Ms. Le Pen’s desire to pull France out of the eurozone has raised concerns that the entire block could unravel. These worries already have hit the debt of Portugal, Italy and other so-called peripheral economies.
Marine Le Pen campaigns at an open-air market in Henin-Beaumont. The vendor supports leaving the Euro.
Mr. Mélenchon doesn’t favor exiting the euro, but some policies he advocates would affect the currency bloc. He wants to scrap the Stability and Growth Pact, which limits deficits in the eurozone.
In a runoff between Mr. Mélenchon and Ms. Le Pen, the sort of trading that hit markets during the eurozone’s sovereign-debt crisis, including extreme volatility in the euro and a selloff in the bonds of weaker members, would re-emerge, some analysts predict.
“That euro breakup risk really becomes a tradable theme if it’s Mélenchon versus Le Pen, if you get a battle between the extremes,” said Ned Rumpeltin, European head of foreign-exchange strategy at TD Securities.
Among other policies, Mr. Mélenchon favors granting a sixth week of annual vacation; encouraging a four-day, 32-hour workweek; raising the minimum wage; and reducing the retirement age. These measures would weigh on French businesses and act as a drag on economic growth, analysts say.
To be sure, most analysts believe that, despite the polls, a Mélenchon-Le Pen runoff won’t happen. Even if one does win the presidency, their ambitions could be capped by France’s parliament, these analysts say.
“It’s all very well having a mandate in the presidential election, but you need support in the national assembly too,” said Philip Shaw, an economist at Investec. Elections to the assembly will be held in June.
But a runoff between Mr. Mélenchon and Ms. Le Pen is “still the one scenario that markets will worry about most,” he added.
Write to Mike Bird at Mike.Bird@wsj.com and Christopher Whittall at email@example.com
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