Wax on, wax off.
Risk on, risk off.
I said it on Sunday: this week would be all about French politics. The relief rally in OATs (triggered by Wednesday’s reports of an alliance between centrist FranÃ§ois Bayrou and Emmanuel Macron) has continued into Thursday after the latest OpinionWay poll showed Macron beating Le Pen 60%-40% in the second round compared with 59%-41% spread in Wednesday’s poll.
OATs extended gains, led by the 10Y-30Y sector with 10Y yields falling to one-month lows:
This is probably a good time to highlight some commentary submitted by a reader on Monday. To wit:
- Mr Macron may well manage to draw more moderate socialists to his camp because of the extreme concern of the Party to be wiped out in parliamentary election following immediately on the presidential vote
- it is also probable Mr Bayrou – a ‘center – left of center’ candidate of past presidential election (with more than 10% of the vote) will decide to support Mr Macron (who will have to pay dearly for this boost)
- By ending up with 23/25 % of the vote in the first round, Mr Macron wins the election in the second round, because Ms Le Pen will not grow much beyond 35/40 % of the votes
Clearly, I should have published that when it was submitted considering Wednesday’s events. Or, as the above mentioned reader put it:
Right – the moment the French election changed course – is today (according to your mail). And you read about it two days ago.
Here’s what Morgan had to say in a note out Thursday morning :
- Who’s likely to become president?Our quantitative approach suggests that centrist independent candidate Emmanuel Macron will likely beat Front National’s Marine Le Pen. With more than two months to go, this prediction can still change. There’s significant uncertainty around FranÃ§ois Fillon, the centre-right candidate of the Republicans,and BenoÃ®t Hamon, the Socialist candidate. In the run-up to the vote, our proprietary models will detect any change in the probability of this key event.
- What would the president do? One of the most underappreciated facts about France is that it’s not going through one election, for the president. But two,as those for the National Assembly,a few weeks later,are as important,given that the Assembly is the main legislative chamber of parliament. Our base case is that a moderate president will have to deal with a fragmented parliament, one where Front National is more represented than currently, but still very far from a majority. If Mr Macron does indeed become president, being an independent, he’ll likely have to work hard to secure support for key reforms. We only expect gradual structural change.
- Le Pen risk overstated: We think that the probability that Ms Le Pen does become the next French president is lower than generally perceived. We doubt this probability is about 25% or even close to 30% (our understanding of the ‘odds’ market participants assign to it, regardless of whether they express this view in their pricing). We think it’s half of that,no more than 15%.
Nevertheless, none of this is keeping markets from pricing increased volatility around the elections and I think it’s safe to say that’s probably a good idea. Here’s Barclays:
In line with the credit and FX risk pricing, nervousness in volatility markets appears to be driven mostly by the French elections as Mrs. Le Pen’s popularity is growing. Figure 7 plots the SX5E and DAX variance spot and forward term structures as well as the corresponding V2X futures levels. Both markets are pricing a growing risk premium for the French elections as per the kink in the variance term structure and the high April V2X future.
At the end of the day, the consensus is that Le Pen won’t prevail, but as Morgan Stanley acknowledges in Thursday’s lengthy commentary, anything is indeed possible in a world where populism fervor “trumps” rationality.