As you know, Marine Le Pen is batsh*t crazy.
As you also know, she’s hell bent on “leading” (and I use that term very, very loosely) France out of the EMU. If she has her way, France will introduce a new franc. For obvious reasons, that will play havoc with some â‚¬1.7 trillion in public debt and another several hundred billion in French IG corporate debt.
I’ve been over this countless times in these pages and it’s still my contention that neither CDS (where the ISDA basis should be much wider given that the 2003 contracts are for all intents and purposes useless) or corporate credit (where the spread between domestic-law and foreign-law bonds isn’t nearly wide enough) markets are pricing this risk correctly. As for OATs, they do their best – bless their hearts.
Well I thought, given today’s headlines…
- First-round support for French conservative presidential candidate Francois Fillon is up one point to 21%, according to a daily poll released Wednesday by Opinionway.
- First-round support for independent candidate Emmanuel Macron and far-right candidate Marine Le Pen is stable at respectively 25% and 26%
- There is no Plan B if Marine Le Pen would win and organize a referendum in France. Firstly, because we don’t know if they would win and secondly, if she would really organize that,’’European Union Trade Commissioner Cecilia Malmstrom says of French elections in April
- 64% of French people are worried about French far-right candidate Marine Le Pen reaching the second round of the presidential election, according to a poll by BVA released Wednesday.
…that it was worth presenting an interesting juxtaposition.
This is from SocGen:
Several clients have been unnerved by a letter which appeared in The Economist at the end of February. “If an issuer does not adhere to the contractual obligations to its creditors, including payment in the currency stipulated, (we) would declare a default,” explained Moritz Kraemer, S&P’s head of sovereign ratings. Yet a currency redenomination would not be quite the same thing as a default, and the two risks should be modelled differently. Leaving aside liquidity premia for the moment, a credit spread is supposed to equal the probability of default multiplied by the loss given default. Thus a bond issued by a company that has a 1% chance of defaulting and an expected loss given default of 60% should be trading at a credit spread of 60bp. For investment grade bonds, the probability of default tends to rise with time (because the future is uncertain, and risks being less good than the present), so the curve slopes upwards. Chart 1 shows a credit curve assuming a 1% instantaneous risk of default, a rise in the probability of 0.25% per annum, and an expected loss of 60%.
In theory, redenomination risk on a bond might be modelled the same way. If a bond has a 5% chance of being redenominated in a new currency, and the value of that currency would then fall by 20% vs the old currency, then the spread of this bond should be 100bp. However it probably does not make sense to assume that redenomination risk rises with time, since it depends on politics. Indeed it is possible to argue that if redenomination doesn’t happen in the next year, it probably won’t happen at all.
Now look, that bolded and underlined passage makes some measure of sense and to be sure, there are very real questions about whether or not Le Pen could actually do what she says she wants to do. But nevertheless (and given how wrong everyone has been regarding populist politicians’ willingness and determination when it comes do doing crazy sh*t), I think that bit from SocGen sets up an amusing compare/contrast scenario with what Le Pen said earlier today and (especially) with what she said on Tuesday. To wit, from Bloomberg:
Presidential candidate Marine Le Pen has repeatedly said the euro is bad for France but she hasn’t always been consistent about what she’d do about it.
On Wednesday, she said she’d introduce a new franc at a rate of one-to-one to the euro and then allow it to fluctuate, even though she and her aides previously said any new national currency would continue to be pegged to a basket of currencies.
“Monday she’s out of the euro, Tuesday she’s not, Wednesday she pegs, Thursday she fluctuates,” said Patrick Artus, chief economist at Natixis Securities. “It’s nonsense and it will never be implemented. We have to stop taking her economic pretensions seriously.”
Last week, in a speech about economic policy, she was more explicit about leaving the euro, and at a conference with a French business lobby in Paris Tuesday she said the single currency “was unsustainable because the discrepancies” between member states are too wide.
She denied that leaving the euro and imposing what she calls “intelligent protectionism” would cut off trade, saying France traded better before joining the European Union. “If I want a new national money, it’s to help us set off to conquer the world,” she said.