French Elections, Global Implications – Citi

What would happen in the event of an unexpected French presidential race outcome (Le Pen/Melenchon in the 2nd round of the election) ? Nothing good, according to many market observers.

Source: Citi

Citi has been trying to figure out what this would mean for financial markets. No surprise there, the unexpected outcome might be bad.

To cite a couple:

  • French government yield spread on Bund would widen (it has already started to do so, reaching as much as 80bp against 50-60 previously). In the worst case scenario, a 200bp is considered possible.
  • Euro would definitely fall, at least in the short term.
  • Credit spread on IG French names, which currently stands at 76bp, might widen by 30 to 40 bp, if you take 2011-2012 as a reference. The impact on non-French IG spreads might be in the range of 15 bp.
  • Equities would fall 5-10% in the case of Mélenchon or Le Pen, but rise 10 to 15% if Macron were to win.
Source: Citi

According to Citi’s strategist Jonathan Stubbs, « strong moves are likely across financial markets whatever the outcome. Both Le Pen and Mélenchon would likely drive “Risk Off” markets with a 5-10% sell-off in French/European equities to end-June, and more risk potentially via enhanced Italian politics. By contrast, a win for either Macron or Fillon could produce “volcano risk” upside for markets. He sees c10-20% upside for French/European equities to end-2017 on a victory for Fillon vs 10-15% upside on a Macron win. »

The global impact for equity markets would be a « Risk-Off » move, and the most quoted point of reference is the eurozone crisis of 2011-2012.

Source: Citi

Risk-off would mean being long bonds and short equities, go to safe haven assets (Gold, USD, JPY) and avoid Euro and EM FX. Global Equities would fall in double-digit range, same for commodities.

Since the ripple effect of Frexit and unknown consequences for Europe at large would probably be more complex to analyze than Brexit, you can expect that financial markets would be in jeopardy for quite some time.

Therefore holding some cash (something investors have been doing at the margin) would definitely make sense.