Between the hammer and the anvil
The French people go to the polls for two rounds of voting in the spring. Markets have belatedly noticed that there is a significant risk associated with this event. In particular, they fear the French people being caught "entre le marteau et l'enclume" (between the hammer and anvil) in the second round of voting in early May.
When faced with a difficult choice between two options, we have a rich menu of metaphors to choose from. Those with a classical bent can talk of being caught between Scylla and Charybdis. For fans of Ella Fitzgerald, it is a choice between the devil and deep blue sea. Most of us would probably discuss being stuck between a rock and a hard place.
However, hop across the Channel and you will find the French talk about being caught “entre le marteau et l'enclume”. Literally translated, that means between caught between the hammer and the anvil. That is a good way of thinking about the market risks associated with the pending French presidential election.
The French people go to the polls in two rounds of voting in the Spring. On 23rd April, the first round of the election will see up to ten candidates vying to become the 25th French President. Assuming no-one wins more than 50% of the vote, the two leading candidates will go forward to a second round of voting on 7th May.
We have been focusing on this issue for months (see for example, Emiel’s 7 questions for ’17 from December last year). However, markets have only belatedly noticed that there is a significant risk associated with this event. The extra compensation required by investors to hold French rather than German sovereign debt has increased sharply to levels reminiscent of the 2011-12 European crisis (see chart below).
The outcome which the market fears the most lurks on the far-right in the form of Marine Le Pen, head of the National Front. Her 144-point plan for transforming France prioritises pulling out of the euro as part of an agenda to restore the “monetary, legislative, territorial and economic sovereignty” of France.
Withdrawing from the single currency, and redenominating French debt into a new Franc would constitute the world’s largest ever sovereign default directly impacting some €2.1trillion of securities. It would be nearly ten times larger than the Greek sovereign default which roiled markets in 2012.
Despite this relatively extreme agenda, Marine Le Pen is almost certainly going to win the first round in late April. That should not surprise anyone given her consistent lead in the polls. However, we should not extrapolate from that to a likely overall victory. When the National Front made it into the second round of the Presidential election in 2002, their vote share barely moved from 17% to 18%.
The scenario in which the risk of a Le Pen victory rises substantially is if the French people are presented with a choice “entre le marteau et l'enclume” on 7th May. If the National Front is the hammer, then the anvil lurks on the left.
The far-left, in the form of Jean-Luc Melenchon, similarly talk about pulling out of the single currency to escape from the “ideological obsessions of the European Commission”. The more moderate left, as personified by Benoit Hamon of the Socialist Party, advocate abandoning the Stability and Growth Pact, a reduction in the working week to 32 hours, and scrapping free trade agreements. If the forces on the left can coalesce under a single banner, their chances of progressing would be significantly enhanced. That will only become clear by 20th March when the final list of official candidates is announced.
The next month promises to throw up further surprises. We will be parsing opinion polls for any indication of rising popularity of the National Front. However, we also need to look carefully at machinations on the left that reduce the chances of a moderate voice making it through to the run-off in May.
In the meantime, we have a cautious outlook on global and European equities partly due to concerns about such inherently unpredictable political risks (see “Going to extremes”). Hedging the risks of euro depreciation also looks appetising for investors looking to avoid getting caught between the hammer and the anvil of French politics in the months ahead.