French Stocks, Bonds Stumble As Communist's Gains Upset Poll Predictions

Following our warnings last week of anxious hedging ahead of the French election, new polls this weekend have stirred the pot of fear further as communist candidate Jean-Luc Melenchon surges making the race a four-way contest with many suggesting this favors Le Pen and the anti-EU voters.

France’s presidential election is becoming a four-way contest as far-left candidate Jean-Luc Melenchon surges to catch Republican Francois Fillon, stoking uncertainty over the outcome less than two weeks before voting begins.

In a sign of the closeness of the race, Bloomberg reports, Fllon turned his sights on Melenchon on Sunday as both contenders held rallies at opposite ends of the country. Fillon sought to rally supporters for a comeback as multiple polls suggest that Melenchon has the momentum going into the crucial final stretch of campaigning.

“The electoral potential of Jean-Luc Melenchon is very high,” said Emmanuel Riviere, a pollster at Kantar Sofres in Paris. Even so, he added, “Fillon has the most solid base.”

Melenchon’s surprise groundswell of support coupled with Fillon’s resilience adds another layer of risk to France’s most unpredictable election in a generation. The latest Kantar Sofres poll published late Sunday had independent Emmanuel Macron and National Front leader Marine Le Pen tied in first place with 24 percent support apiece, followed by Melenchon with 18 percent then Fillon 1 point behind.

And unsurprisingly, jitters over the outcome of the France’s presidential election have increased after the far-left politician Jean-Luc Melenchon jumped in the latest polls, making the election a four-way contest, and boosting the small possibility of a second-round contest between the Communist-backed candidate and the anti-euro Marine Le Pen.

As we noted before, as the French election looms, investors are increasing bets on the nation’s stock-benchmark gauge. The number of options on the CAC 40 Index has surged to its highest level since 2011, while remaining stable on the regional Euro Stoxx 50 Index.

Since last month’s expiration, call open interest rose 26 percent, outpacing the 22 percent increase in puts outstanding.

And FX traders remain anxious, The cost of one-month options to buy the common currency against the yen plunged Thursday, relative to contracts for selling, to the lowest level since June.

 

And it appears investors are reacting to Melanchon's gains...The yield difference between French and German 10-year bonds widened three basis points to 70, the highest since February, based on closing prices, while a measure of two-week euro volatility against the dollar spiked to 10.60 percent, the highest in more-than three months. The CAC 40 Index fell 0.5 percent, underperforming a wider European gauge, with Societe Generale SA, BNP Paribas SA and Natixis SA among the top 10 fallers among the region’s banks..

 

In reaction to this sudden shift, Goldman downgrades French bonds... 

We recommend going tactically short June French futures (OATM7) at 147-72, for an initial target of 144.00, and stops on a close above 150.00. This position allows one to take a directional view on duration in a market that scores as very expensive on our valuation metrics.

 

In relation to the risk to this trade emanating from the political sphere, a victory by a moderate reformist candidate (e.g., Fillon, Macron) - which is our European Economics team base case - would result in a narrowing of French bond spreads (the 'fair level' to Bunds is in the region of 30-40bp, from 70bp currently) but offset by a sell-off in core rates. We would expect French bond spreads (and yields) to come under upward pressure if the first round of the Presidential election were to result in a strong showing of anti-establishment parties (e.g., Le Pen, Melenchon). By contrast, US Treasuries may instead rally on the event, on the back of flight-to-quality flows.

Mike Shedlock warnsLe Pen’s Chances Far Greater Than Most Think

While it is unclear now if Le Pen (or anyone else) makes it to round two, her chances of winning are far greater than most think.

The known anti-EU vote is Le Pen + Mélenchon + Asselineau. That totals 42.5%.  Is there more lurking somewhere else?

And what if the final pairing is Le Pen-Fillon. Will socialists really support Fillon?

I believe they will turn out for Le Pen in spades. Why? Because the odds of Le Pen being able to push through the legislation to take France off the Euro are slim.

Fillon, on the other hand, may be able to force through all kinds of badly needed reforms that the Left despises.

Nightmare Scenarios

  1. For the Left: Le Pen vs. Fillon
  2. For the EU: Le Pen vs. Mélenchon
  3. For the Right: Le Pen vs. Mélenchon

Either Le Pen or Mélenchon as a final winner would be exceptionally distasteful to the EU.

Those are very possible outcomes. Mélenchon is a social media star like Trump. He also uses video games and holograms. The Financial Times reported Mélenchon was “the first French presidential candidate to do a speech by hologram, enabling him to talk to crowds in Lyon and Paris at the same time.” He has 260,000 You-Tube subscribers.

Instead of just having to worry about Le Pen, the EU can now worry about Mélenchon as well.

 

So what? we hear the American stock market investors cry... we are higher and so that's what really matters, right?

Well here's a reminder of the last 2 major votes...