Macro Digest: The biggest surprise in French election? The EUR!

French election – what is the real surprise so far?

The French election has seen several major surprises, but the biggest surprise market wise has been how well the EURO has been able to trade despite serious headwinds from Brexit and the rise of anti-Euro candidates.

This "chaos" has been seen in FX Risk Reversals and bond spreads but not really in the EUR.

EURUSD 25 delta Risk Reversal (Put bid over Calls)

Source: Bloomberg LLP

The EUR puts cost 400 bps more than the equivalent EUR calls…..and from a "near certain Macron victory in early March the market now fears a second round of Far-Left vs. Far-Right, Melenchon vs. Le Pen, but this is still unlikely in my opinion. The "real surprise" would be Fillon vs. Le Pen or Fillon vs. Macron.

Meanwhile the German vs. France Bond Spread (here 2 YR Government yield) has continued to expand:

2 Year France – Germany Government bond spread

Source: Bloomberg LLP

In a "normal market" these elevated risk levels would have meant a EURUSD fx rate trading somewhere between 1.00/1.03 instead of 1.0690 at the time of writing.

The outperformance or "premium" is partly explained by Europe growth velocity which continues to expand….

Bank of Italy, Ecocoin Growth Indicator

Source: Bloomberg LLP

Partly also that European equities still trade at a big discount to especially the US market, which has fed a continued stream of OVERWEIGHT recommendations…

Add this to the "real economic fundamentals" of a large current account deficit (3.35% of GDP) and a "discount" in inflation (Euro: +0.7% vs. US +1.7% - the low inflation currency will outperform high inflation over time due to change in purchasing power)

Euro Current Account Surplus (% of GDP)

 

Non-European are extremely nervous about the French election, partly from the bad experience of Brexit and the US election, but also because they fear Le Pen (and now Melenchon) will pursue an agenda of Frexit  - there are so many flaws in that theory, but first let's look at the book makers prices for the election (and Yes, they were wrong twice before)

 

Odds for President of France – (www.oddschecker.com)

Source: Oddschecker & Bloomberg LLP

What's really interesting in this "betting based" President poll is that Le Pen now has LESS CHANCE than Fillon of becoming President!!!!!

Maybe real surprise is a Macron vs. Fillon second round?  J

Back to the "concern" about the Euro being targeted by Le Pen or Melenchon – here I want repeat the procedure in France and the famous article 89 in the French Constitution:

Article 89 - link

"The President of the Republic, on the recommendation of the Prime Minister, and Members of Parliament alike shall have the right to initiate amendments to the Constitution.

A Government or a Private Member's Bill to amend the Constitution must be considered within the time limits set down in the third paragraph of article 42 and be passed by the two Houses in identical terms. The amendment shall take effect after approval by referendum.

However, a Government Bill to amend the Constitution shall not be submitted to referendum where the President of the Republic decides to submit it to Parliament convened in Congress; the Government Bill to amend the Constitution shall then be approved only if it is passed by a three-fifths majority of the votes cast. The Bureau of the Congress shall be that of the National Assembly.

No amendment procedure shall be commenced or continued where the integrity of national territory is placed in jeopardy.

The republican form of government shall not be the object of any amendment"

The Prime Minister, the government or a 3/5 majority is needed even to table an amendment to the Constitution, so yes both Le Pen and Melenchon can become Presidents but the Constitution stops them from being able to execute, as the Parliamentary election in June will not give them the political power to rule – a vacuum could develop and that's the most likely risk independently of whether it's Le Pen, Macron, Melenchon or Fillon who is France's next President

The French election will in that way be no different to Trump's victory in the US. Yes, "they" may grab the power, but the ability to change the political process is very different from winning a lottery of an election – Just ask President Trump!

We still believe in Macron as President, but we are defensive enough to recognize this election will be close, maybe too close for comfort as the populous movement have a lot of ammunition due to the inequality and the poor performance of the economy.

Their solutions however is a romantic, if not naive, version of the 1950s and 1960s when the world was less complicated, had less trade and less technology.

Today's world needs visions and all the election including now the UK one have little outlook to that, if anything this political cycle may have another two years of running before voters again is seeking a future defined by more competition, more basic research, open trades and innovation, the very definition of productivity which is the only long term solution which is neither political or inequal.

I see the EURUSD trading above 1.1000/1.1200 post the June Parliamentary election in France, a Le Pen/Melenchon election could mean test of parity, but the above fundamentals will drive EURUSD back to 1.0500 quit quickly.

Steen Jakobsen

Med venlig hilsen  |  Best regards
Steen Jakobsen  |  Chief Investment Officer

 

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