Bond investors are betting Marine Le Pen has little chance of becoming president of France, but her policies are so unnerving to markets that even this limited probability has pushed volatility in French government bonds close to 2012 sovereign debt crisis levels.
Average intraday volatility in 10-year French treasury bonds — the highest yield minus the lowest on any given day — has averaged 6.6 basis points in the last two quarters, according to data compiled by ABN AMRO, a 43% increase on the average for quarters two and three in 2016. Similar trends can be seen in France’s five- and 30-year bonds.
Marine Le Pen is likely to lose to centrist Emmanuel Macron in the second round of the French presidential elections, polls show.
Source: Associated Press
Recent volatility has been below, but close to, levels seen during the height of the European sovereign debt crisis in mid-2012, according to ABN AMRO strategist Kim Liu.
The shift has left French OATs looking more Irish than German — the eurozone market benchmark for low risk. The correlation between French and Irish government bonds in the last 30 days has been 0.58, while the correlation to Bunds has been just 0.3.
In fact, French bonds have the lowest correlation with German bonds of all core and semi-core European countries in the last 60 days, a phenomenon closely tied to political risks, said Liu.
With French five-year credit default swaps trading at 49 basis points, compared to Italy's 170, investors' base case is still that the far-right's Le Pen will be defeated, as opinion polls would indicate. But the volatility data are a sign that they are not confident of this view, and are concerned by the financial havoc she might wreak if she does seize the keys to the Élysée Palace, which might prove difficult for even the European Central Bank to contain.
The latest Elabe poll on March 29 showed independent centrist candidate Emmanuel Macron winning the first round on April 7 with 25.5% of the vote to Le Pen's 24%. Most polls suggest Macron would crush Le Pen in a runoff on May 7 with more than 60% of the vote.
This has strengthened the conviction of investors who think the market is overstating the risk of Le Pen becoming president.
One of them is Cosimo Marasciulo, head of European fixed income at Pioneer Investments, who sees any spread widening as a potential buying opportunity in OATs.
"The widening of French government bond spreads is probably overdone in the medium term," he said. "However, in the short term, markets might react negatively to Le Pen winning the first-round vote, and spreads could widen even further.
"We might be interested in buying French government bonds at wider spreads, so we will be watching carefully that period after the first vote for potential opportunities."
But bond market volatility could increase further if Le Pen does better than polls suggest in the first round next month.
The spread between French and German government bonds has tracked her polling numbers this year, said Rabobank analysts in a note on Wednesday.
"The two weeks between the first and second round will be an especially tense period," they said.
'Too important to ignore'
Investor caution around the French election has been amplified not only by the potential consequences of Le Pen’s policies, but also by distrust of political polling fueled by shock results in the U.K.'s Brexit referendum and the U.S. presidential election last year.
Le Pen plans to hold a referendum on France's membership of the European Union and drop out of the euro, redenominating the country's debt in a new franc.
"It is difficult for investors because they don't have much information apart from the polls," said ABN AMRO's Liu.
"We have seen spreads come in as Macron's chances have improved, but the question is whether investors are getting enough spread to compensate for the risk."
"The French-German 10-year spread is around 60 basis points now, but in the event of a Le Pen victory the spread could easily widen to over 200 basis points."
In a note published March 28, UBS analysts called the risk of Le Pen becoming president "non-zero," adding that the potential consequences across asset classes were "too important to ignore."
A Le Pen victory would arguably be comparable to the height of the eurozone debt crisis in mid-2012, they said, when their European spread metric widened some 500 basis points.
That extreme scenario would cause a 10% drop in the value of the euro and a 35% dive in European stocks, they added.
The poll problem
When Le Pen's father, Jean Marie, made the second round of the 2002 presidential election, left-wing and centrist voters united behind the conservative Jacques Chirac, who won by a landslide. But Marine Le Pen, who has striven to clean up the National Front's long-thuggish image, polls far better than her father ever did, and some analysts suspect her support may be higher than surveys indicate.
"Political correctness leads people to lie in the polls," said Goldman Sachs strategist Bobby Vedral in a note to clients earlier in March, adding that it was "at best naïve, at worst negligent" to assume she couldn't win the presidency.
The Elabe poll showed that 86% of those saying they would vote for Le Pen would not be changing their mind before the election, compared to just 62% for Macron.
Some 41% of those polled said they would be abstaining, another factor likely to favor Le Pen.