FRENCH ELECTIONS: This is the worst case scenario for the markets

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FRENCH ELECTIONS: This is the worst case scenario for the markets

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Reuters

• Bank of America Merrill Lynch's European economics team assessed the market impact of all six potential first-round outcomes.
• Marine Le Pen versus Jean-Luc Melenchon in the second round is the most market negative scenario.
• Emmanuel Macron facing Francois Fillon is the only guaranteed market positive run off.

LONDON — As France prepares to go the polls in the first round of one of the most hotly contested presidential elections in the country's recent history on Sunday, the outcome is less clear than ever before.

As it stands, four different candidates are polling at around 20%, and could realistically end up in a second round run-off.

Centre-left Emmanuel Macron leads the way in most polls on around 24%, closely followed by far-right Marine Le Pen on 22-23%. Veteran far-left candidate Jean-Luc Melenchon and former Prime Minister Francois Fillon are generally polling between 18-20% each.

The chart below, courtesy of Bank of America Merrill Lynch shows just that:

BAMLWhile Macron remains the heavy favourite to win — polls show him defeating Le Pen roughly 60%-40% if the election's second round is between the pair — the possibility that four separate candidates could make the second round is making investors in French assets increasingly nervy.

France is the eurozone's second-largest economy, and whatever happens market reaction overnight on Sunday and early Monday morning is likely to be significant.

There are six potential outcomes that could materialise after the vote, with each posing different challenges to the markets. Writing on Friday, BAML's European economics team, headed by Gilles Moec, argued that only one possible outcome would actually be seen as a total positive for the markets.

"Our scenario analyses indicated that out of these 6 combinations, only one would be "market friendly" (Emmanuel Macron vs François Fillon) in the sense that their stated policies suggest both would strive to keep France in the Euro area and, to varying degrees, would implement reforms to spur potential growth," the team wrote.

By contrast, all other scenarios present at least some substantial element of downside risk to the market. One scenario, with far-left Melenchon and far-right Le Pen making the run-off, is particularly "market adverse," Moec and his team said. That stems from the fact that both candidates are "euro-sceptic to varying degrees and supporting ultra-loose fiscal policy and a re-regulation of the French economy."

BAML's handy comparison table, which can be seen below, illustrates the market impact of every potential outcome:

BAMLBAMLBAML

Le Pen and Melenchon both reaching the second round may be an extremely unlikely event, but should it happen, markets would likely see a substantial sell-off on Monday morning, with fears about the potential break-up of the eurozone coming into sharp focus given the certainty of having a hugely eurosceptic leader at the helm of one of the key pillars of the continent.

Bond markets could be particularly impacted, with the spread between French government debt, known as OAT, and German Bunds widening by a substantial amount. "OAT-Bund spreads have the greatest room to widen in case of a Mélenchon vs. Le Pen outcome," Deutsche Bank's Abhishek Singhania wrote on Friday.

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April 22, 2017 at 07:24PM