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Investors lean towards market-friendly French election outcome

Investor sentiment is leaning towards a market-friendly outcome ahead of Sunday’s first round of voting in the French presidential election.

The euro was on course for its best week in three months near $1.07, while a key proxy of election risk, the premium demanded by investors to own French government bonds over German Bunds, has narrowed sharply.

“The most likely outcome is for a second round run-off between Marine Le Pen and Emmanuel Macron, a more centrist candidate. Macron would then be the likely winner, having held a consistently large poll lead over Le Pen in second round voting,” said Nick Peters, multi-asset portfolio manager at Fidelity International.

“Should we see this outcome, it would be positive for markets, with the euro rallying and the spread on French over German bonds likely to fall.”

Investors have focused on risks emanating from Marine Le Pen’s anti-euro stance, though the emergence of Jean-Luc Mélenchon as an alternative Eurosceptic candidate has complicated the picture. According to the latest polls, Emmanuel Macron is leading at 24 per cent, followed by le Pen on 22 per cent. Both François Fillon and Mélenchon are on 19 per cent.

The favoured market outcome would be a run-off between Mr Macron and Mr Fillon, but in such a scenario the current risk premium only pushes the euro to $1.10 against the dollar according to Derek Halpenny, head of global markets research at MUFG.

Yields on 10-year French government debt have narrowed to about 60 basis points, compared with 78 basis points just last week, according to Reuters. In September, before French electoral fears began to rise, the spread was just 20 basis points.

French equities have shown little evidence of any nerves, with investors focusing more on signs of an improving eurozone economy. The CAC 40 index of French blue-chip shares is up 3.9 per cent in 2017 and this month hit its highest level since the global financial crisis.

Despite signs of some market optimism ahead of Sunday’s vote, in which the country’s four candidates will be whittled down to two, an undercurrent of unease remained among investors.

“Most of our clients remain quite concerned about what could happen on Sunday,” said Vincent Juvyns, global market strategist at JPMorgan Asset Management, who said the vote was “much more important than Brexit”.

He added: “There is a probability of a very negative scenario on Sunday evening which would bring us great uncertainty in the coming weeks and months, and at this stage we do not need this uncertainty.’’

Yianos Kontopoulos, global head of macro strategy at UBS, noted in research on Friday that the “least priced” outcome, which is according to polls unlikely, is Le Pen facing and beating Mélenchon in the second round. UBS has stress-tested a Le Pen victory, and estimates European stocks would fall 7.6 per cent, and that Bunds and US Treasury yields would decline alongside a widening in peripheral spreads.

One reason markets seem relatively calm on the surface is that some investors have already taken positions in options markets to hedge against a sell-off for the euro.

The euro/US dollar one-month “risk reversal”, which measures the extra amount traders are prepared to pay for contracts that protect against a fall for the common currency, has reached its most extreme ever level, according to Bloomberg calculations.

TwentyFour Asset Management, a London-based investment house, said it has taken a small option position on a weaker euro against the dollar, adding that correlations between a weaker euro and wider credit spreads — which it aims to hedge against — would be “very strong”.

Read more about the French election
Lex: The Macron manoeuvre
FT Magazine: A guide to the electoral tribes of France
News: Macron strives to win over waverers
Poll tracker: Who is leading in national opinion polls?

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