France’s 2017 Elections Provided a Very Different Market Stress

(Bloomberg) -- The first time Marine Le Pen’s far-right party got close to winning power in France, agitated investors drove up bond yield premiums out of concern for the potential economic damage she might cause.

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In the end, Le Pen’s 2017 presidential bid failed — the business-friendly upstart Emmanuel Macron beat her 66% to 34% in the second round of voting — and markets rallied in response.

This time around, Le Pen’s National Rally is polling in first place for the snap parliamentary elections that begin Sunday, and bond investors once again are worked up, this time joined by equity investors. A market-friendly outcome is unlikely, with a left-wing coalition running in second place on promises to raise taxes and spend more.

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The parallels between 2017 and 2024 are limited — seven years ago, central banks had pushed interest rates to below zero to try to revive the global economy, whereas today they’re much higher after a post-pandemic surge in inflation.

Still, in both elections investors have shown how sensitive they are to political and regulatory risk, and traders are dusting off their playbooks from seven years ago to prepare.

Here is a look at how asset classes were behaving then and now.

Bonds, Now and Then

Macron’s surprising June 9 decision to call the election spooked bond investors: They immediately demanded a yield premium of as much as 80 basis points to hold French government bonds over German ones, up from less than 50 basis points. That spread was the highest since the euro-area crisis more than a decade ago.

While the premium has fallen slightly this week, positioning among traders in equivalent bond futures suggests they’re still betting on higher French yields. The widening is more a consequence of the drop in German yields than a surge in French ones, an indication of a flight to safety.

Back in 2017, the spread between French bonds, known as OATs, and German bunds spiked in similar fashion before the first round of the presidential election, then tightened again after Macron’s first-round win, as markets priced in a strong likelihood of a Macron presidency.

One key difference between this year and 2017 is that, back then, Le Pen was proposing to pull France out of the euro, a positions she has now backed off of. The prospect, however remote, that the euro would collapse, resulting in government bonds denominated in revived national currencies, meant that Italian government bond spreads also widened in 2017.

“Most of the impact has centered on French assets, unlike what happened during the 2017 French presidential election campaign,” Goldman Sachs Group Inc. strategists including Lilia Peytavin wrote in a note.

Meanwhile, fixed-income volatility — a gauge of investor uncertainty — jumped this month from a near two-year low to a five-month high following the unexpected call for an election. In sharp contrast, price swings in 2017 fell, because the European Central Bank was in the midst of a huge bond-buying program aimed at boosting the region’s anemic growth.

Stocks, Then and Now

For equities, the setup in 2017 was completely different. The CAC 40 had been rising in the weeks into the election, with a small drop on the eve of the first round. Back then, globally loose monetary policy was a major boost for equity markets. This time around, the benchmark has fallen 4.3% since Macron’s decision to call the election, with investors fretting about populist economic policies from both the National Rally and the left-wing New Popular Front coalition.

In terms of valuation, the MSCI France Index traded at similar levels in 2017 and now, at 14 to 15 times estimated earnings. Yet French stocks weren’t trading at a premium to the rest of Europe in 2017, in contrast to 2024. In fact, the recent pullback in French equities has brought them back to their relative long-term median valuation, removing that premium.

As with bonds, the first round of the presidential election on April 23, 2017, triggered a rally in stocks — the CAC 40 soared 4.1% the following day, one of the biggest gains for the benchmark over the past 10 years outside the pandemic period.

Societe Generale SA, one of the stocks that’s fallen the most this month since the election announcement, was volatile ahead of the vote in 2017 but rallied nearly 10% the day after the first round. Shares of other badly affected stocks such as infrastructure and construction companies Vinci SA or Eiffage SA experienced comparable price action.

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While stocks now don’t have support from low interest rates and loose monetary policy as in 2017, the European economy has shown sign of recovery and earnings estimates are on the rise. Meanwhile, the ECB has started cutting rates this month as inflation has cooled.

Yet investors aren’t complacent. The options market is pricing similar risk to French equities as back in 2017, with the spread between the one-month implied volatility for France’s CAC 40 and Germany’s DAX Index surging to about six points.

Based on the polling, this year’s election — the second-round vote is July 7 — is likely to result in the far right or the left being the biggest party in Parliament. That, in turn, would probably prompt Macron to choose a prime minister from their ranks. From investors’ perspective, the only consolation would be that stocks and bonds might have already priced in that outcome, leading to a rally in the aftermath of the vote.

“Markets tend to overreact to political risks, and we think this is another case,” UBS Group AG strategists led by Gerry Fowler wrote in a note last week, seeing a buying opportunity. “Markets tend to force compromise eventually and politicians likely know this.”

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