Your Cheat Sheet for How Election Jitters Will Affect France

  • Nation’s 10-year bond futures likely to feel brunt of selling
  • Bank stocks will be most sensitive to stress over fate of EU

And so to France.

As a wave of populism makes political risk the biggest concern for analysts in 2017, the French election represents one of the next major potential flash points.

With front-runner Francois Fillon facing a criminal probe into hiring his wife as an aide, investors are weighing the prospect of President Marine Le Pen. The National Front leader says Europe’s single currency is “destroying” her country’s economy.

Here’s where the risk may show up first in rates and credit markets:

Yield Spreads

An increase in political risk premium in French bonds should result in some widening in the yield spread over core countries, such as Germany. The France-Germany 10-year yield spread has been gradually increasing since November, but that may have been influenced by French bond sales and reduced buying support from the ECB.

France’s yield spreads over peripheral nations may be less predictable, as a Le Pen victory would likely result in a flight to quality and so away from the periphery.

Open Interest

The brunt of any selling would likely be felt in the liquid futures market of the French 10-year bond, as was the case after Trump’s election victory. Investors often look at the open interest -- the active number of bets -- which can leave footprints as to when positioning changes. Currently, front-month OAT futures have a record-high open interest, which may increase as we approach the election.

OAT futures are breaking critical support at 148.73, which represents a peak and breakout point from 2015. Such technical development introduces the 50 percent correction line at 147.44 and then the 61.8 percent Fibonacci of the 2015 to 2015 rally at 144.86.

The medium-term outlook remains negative following the violation of the 2013 bullish trendline in the week of Trump’s election win. The near-term resistance is at the January high of 152.52.

Credit-Default Swaps

France’s five-year credit-default swaps have retraced about 50 percent of the post-Brexit gains following Trump’s election victory.

Both France and Germany have been forces for economic and monetary union, and each country has a general election this year. The outcomes will be key to the stability of the euro and, in the medium term, to credit risk.

Inflation Swaps

Fillon has proposed increasing value-added tax rates by 2 percent. That’s widened the spread between front-end French and euro inflation swaps, as it may induce inflationary pass-through.

Banks

Banking stocks, which have been the most sensitive to concern about the fate of the euro zone, are the most vulnerable to rising political risk. French automakers, which have a strong exposure to Europe, would also feel the impact. Big multinational groups such as Sanofi, LVMH Moet Hennessy Louis Vuitton SE and Total SA, which have a small exposure to France, would be more protected.

France’s benchmark equity index, the CAC 40, has gained 0.5 percent this year while Germany’s DAX added 3.3 percent and Italy’s FTSE MIB rose 2.4 percent.

— With assistance by Tanvir Sandhu, Blaise Robinson, and Sejul Gokal

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