What French election

Markets drop their guard ahead of French election

Are European markets particularly bothered about the final round of France’s general election on Sunday? Risk indicators suggest not.

Investors and traders might be getting used to that sinking feeling the morning after a shock vote result, but the risk that pollsters will be proved spectacularly wrong—again—are being read as greatly diminished this time.

France’s two-stage voting process itself removes much randomness from the range of probable outcomes. The consistent and strong poll lead by centrist candidate Emmanuel Macron against far-right Marine Le Pen, since March, and in both rounds, crushes the odds even further. On Friday night, the latest poll, published by Ifop Fiducial projected Macron would beat Le Pen by 63% to 37% in the run-off.

In line with that expectation, for much of Friday, investors have been more worried about markets that are wider and further afield than France’s. Equities got off on the wrong foot in Asia and subsequently in Europe early on after oil futures fell more than 3% to below $47 a barrel at one stage as oversupply worries bit deeper. Then, in afternoon trading, a much stronger than expected U.S. non-farm payrolls figure looked set to rekindle the flagging dollar, and possibly stocks too. But momentum was short-lived as drag from one or two giant U.S. stocks, like IBM, was too great. In short—the market had plenty of worries, though not particularly about Sunday’s election.

Major indicators of French and wider European market risk appetite underscored sanguine sentiment. Ironically of course, in the—seemingly very unlikely—event of a shock result, the impact on a broadly unguarded market could be magnified. 

The cost of insuring French euro-dominated debt is in focus because of Marine Le Pen’s wish to take France out of the Eurozone. However, France's 5-year Credit Default Swap, trading at its lowest since early November, suggests French investors with significant euro exposure think they can rest easy.

It’s a similar picture in the currency trade that has come to be associated with French election risks most closely. In fact, whilst the euro traded against the dollar and other major currencies have reflected the market’s anxieties over who might win, the more volatile EUR/JPY pair has particularly come under the spotlight due to its higher volatility, and the safe-haven aspect of the yen.

That doesn’t mean EUR/JPY is sounding any alarm bells now though. Nor is the market for hedging or speculating on euro/yen exposure. The one-week at the money option should capture sentiment around Sunday’s vote and any near-term fallout.

The chart depicts implied volatility. Implied volatility is directly tied to the price option traders are willing to pay to hedge/speculate on increased variance (volatility) over the course of the contract. Right now, this chart says demand for the trade isn’t high and quite cheap relative to prices seen before first round voting. Volatility is also lower than on the day after the Brexit vote. Again, not much anxiety to see here, right now.

Moving on to the stock market, Europe’s version of the VIX Volatility Index—The VSTOXX—which is based on Euro STOXX 50 futures, would surely reflect signs of heightened investor risk aversion, if there were any.

Well, investors in Europe’s 50 largest shares are less inclined to hedge against the risk of drawdowns on the weekend of one of the most important elections in Europe than they were ahead of the Brexit vote, the U.S. election, or indeed the first round of the French election. European stock market volatility seems to be heading back towards multi-year lows seen over the last few months as many regional economies revive, corporate earnings bounce, and the euro stays relatively and advantageously weak.

Investors in French government bonds have also stood down since Macron won the first round of the election on 23rd of April. Not that any ‘panic’ seen in the days leading up to that date in any way matched the intensity of the mood in winter months of 2011. Then, the Eurozone sovereign debt crisis was at its height and runs on Greek, Italian, Spanish and yes, French bonds, pushed spreads versus Europe’s benchmark, 10-year bunds, wider than has ever been seen since. We’re a long way from there now.

All the above said, pollsters have been famously wrong a number of times over the past year, at great cost to investors. Should anti-establishment voting sentiment rear its head yet again on Sunday, financial pain will be just as great as after the Brexit vote, regardless of what spreads, volatility and CDS are telling us right now.