April 5, 2017 / 9:47 AM / 5 months ago

Markets snooze their way to Le Pen showdown

French National Front political party leader and candidate Marine Le Pen delivers a speech after results in the Nord-Pas-de-Calais-Picardie region for the second-round regional elections in Henin-Beaumont, France, December 13, 2015. REUTERS/Yves Herman

LONDON (Reuters Breakingviews) - Markets are snoozing their way to a Marine Le Pen showdown. French government bond prices suggest a lower probability than the bookies do that the National Front leader will win the imminent presidential election. The big challenges to investors’ sangfroid would be voter apathy or a left-wing alliance – both the kinds of thing that defy traditional market analysis.

Le Pen has pledged to rip France out of the euro. So one gauge of her chances is the cost of insuring French debt. Such contracts would pay out if France redenominated its currency. Right now, the cost of a five-year credit default swap is 52 basis points. Assume a new franc is worth 30 percent less than a euro, and that price indicates CDS investors think there is a near-2 percent chance of France redenominating its debt in the next year, or 8 percent over the next five years.

An alternative is to guess where French government bonds might trade if Le Pen were to win. Typically French 10-year bonds yield more than German equivalents, but that gap has ranged from 190 basis points, back in 2011 when a breakup of the euro zone seemed close, to 50 basis points in relatively calm 2014, before the European Central Bank started buying bonds and distorting prices. Measured on that spectrum, the current difference of 67 basis points would imply a roughly 12 percent probability of Le Pen taking the Elysee.

Reading the markets this way involves big assumptions. The franc could fall more, or less, than 30 percent, and credit spreads aren’t always a pure reflection of likely losses. Le Pen could win but fail to force a referendum on the euro. A simple third way, then, is to ask the bookmakers. William Hill’s odds, for example, imply a 27 percent probability of a Le Pen presidency.

Voter polls still predict a comfortable victory by centrist candidate Emmanuel Macron in the second round. That doesn’t mean Le Pen can’t win. If left-wing candidates Jean-Luc Melenchon and Benoit Hamon team up, they could displace Macron and make it to the second round, leaving centrist voters adrift. And, after years of a fragile economy, voters may stay at home, benefitting Le Pen over mainstream candidates. In short, while a Le Pen victory seems unlikely, the margin of error is wide.

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