The Real Political Risk In France

The Real Political Risk In France

There are many areas where Anatole and I agree to disagree. But one in which the two of us see eye to eye is the heightened influence political risk may have on markets this year. Consider France, where the political situation threatens to get complicated. The problem is not so much the presidential election, due to be held in two rounds in April and May, but the legislative elections set to be held a month later. 

Assuming no candidate wins an outright majority in the first round of the presidential election—which is a safe bet—the second round run-off will pit the two leading contenders against each other. One of these will probably be François Fillon, who represents the traditional right (although in any other country, he would be considered relatively left wing). The other second round contender is likely to be either Emmanuel Macron (a representative of the left, who claims to be on the right), or Marine Le Pen, (who represents the extreme right, but promotes herself as standing on the left. This is, after all, France).

My bet is still that the second round will pit Fillon against Le Pen, and that Fillon will win. But Fillon’s candidacy is currently going through a rough patch, with French prediction markets now putting the probability that he will win at just 30%, down from 60% at the beginning of January. And if Fillon fails to make it to the second round, let alone to the Élysée Palace, the potential effects on the subsequent parliamentary election are troubling.

In the past, the first round of the parliamentary election in each constituency typically saw three main candidates go head to head: a candidate from the traditional Republican right, one from the Socialist Party, and one from Le Pen’s far right National Front.

The story was always the same. If the National Front won a sizable share of the first round vote, then in the second round either the Republican or the Socialist candidate—whichever won fewer first round votes—would withdraw, in order not to split the anti-National Front vote. This arrangement was known as the “Republican Front”,  and proved effective at shutting the far right out of parliament. In the last election in 2012, the National Front won just two seats. 

Now, however, things are getting complicated. Within the Socialist Party, there is now a fight to the death between what are called the “government socialists” and the “revolutionary” socialists . The revolutionary socialists have just taken control of the party. However, they appear no more able to manage a political party than their “Corbynista” opposite numbers Britain. As a result, each constituency election could now see not one socialist candidate standing for election, but three: a revolutionary socialist, a representative of the old socialist left, and quite possibly a third socialist running under Macron’s flag.

These different socialist factions loathe each other at least as much, if not more, than they hate the traditional right or the National Front. It is not at all clear that any of their candidates will agree to withdraw from the second round election should it look as if the far right candidate stands a chance of winning. As a result, for the first time, this year there is a fair chance that the National Front could win a significant number of seats. 

What’s more, if Macron succeeds in winning the presidency, a lot of candidates from the traditional right will be so disgruntled by the defeat of their candidate Fillon that they may break ranks to create an alliance with the National Front at the local level, especially in the South. 

This matters. Some 60% of the French electorate is “of the right”. Yet the right has managed to shut itself out of power in recent years, largely because of the traditional right’s strategy, imposed by former president Jacques Chirac, of never talking to the National Front.

In short: while most people are focused on the presidential election as the main source of French political risk this year, it is quite possible that the subsequent legislative elections could lead to a totally ungovernable parliament.

That could mean a totally ungovernable country, which would likely eventually force the president to dissolve parliament. But he can only do that once in a year. So if the popular vote again returns an unruly parliament, it is possible that the president may have to resign.

The upshot is that anyone who thinks political risk in France will be settled by the presidential election may be in for an unpleasant surprise. It could be followed by a very hot summer. 

It seems the markets are beginning to get wind of this danger. As the chart overleaf shows, the yield spread between French and German 10-year government bonds has just gapped to its widest in almost three years. Fasten your seat belts. There may be turbulence ahead.

This article was originally published on Gavekal.com. Copyright 2017.