News: Bond markets have been particularly volatile in recent months, mainly due to political risk and the rise of populism. Some investors are even talking about France leaving the eurozone (« Frexit ») and the consequences of converting French debt into francs. Why is the worst being considered?
1) Unfavorable polls
With just two months to go before the first round of the presidential election, uncertainty reigns. Beyond the many twists and turns of the campaign, investors are concerned about the possibility of the eurozone breaking up. However, at this stage, the candidates in favor of France leaving the eurozone would not receive enough votes to win the presidential election.
2) The scenario of a « Frexit » referendum: a significant possibility if Article 11 is invoked
The victory of Marine Le Pen, the far-right candidate who supports a « Frexit, » could be seen as the first step toward France’s exit from the eurozone. However, even if elected, Marine Le Pen would technically face difficulties in organizing a referendum on France’s membership in the eurozone. This is because invoking Article 89 to revise the Constitution requires the support of the National Assembly and the Senate, and the National Front currently has only two elected representatives in the Senate. However, history reminds us that Article 11 allows this constraint of Article 89 to be circumvented through a revision of the Constitution.
3) Why are the markets panicking?
The bond markets are demanding a risk premium specific to France. The rise in French interest rates reflects the financial markets’ concern about a populist vote and its dramatic consequences for the eurozone, with investors viewing the Franco-German axis as essential to the eurozone’s survival. As proof of market nervousness about French risk, the CDS[2] spread on France doubled in 2017 before quickly returning to around 50 basis points (following the latest polls and the Macron-Bayrou alliance).
This decoupling between good economic data and market valuations illustratesa certain break with the behavior of market players in recent years. Since Mario Draghi’s famous » whatever it takes « statement, market players have been confident in the ability of central banks to intervene in the event of a shock (see the 2012 debt crisis). Relying heavily on central bank monetary policies, the markets have been unable to correctly assess political risk, for example in 2016 with Brexit and the US elections.
Conclusion
The recent rise comes against a backdrop of very accommodative monetary policy and encouraging signs from the French economy (PMI, employment figures, etc.). Now, the opposite is happening: markets are more (and probably excessively) concerned about French political risk than economic fundamentals.
[1]The next senatorial elections will take place on September 24, 2017. However, it is unlikely that the National Front will obtain enough votes.
[2]Premium paid under an insurance contract against the risk of default by France. The higher the perceived risk of default by France, the higher the premium paid in return.
[3]In the summer of 2012, the eurozone was on the brink of collapse. Mario Draghi’s speech calmed the markets by announcing that the ECB was prepared to do whatever it took to preserve the eurozone: » Within its mandate, the ECB is ready to do whatever it takes to save the euro. And believe me, it will be enough. »
[4]Investors rushed to German debt, considered a safe haven, fearing exposure to the eurozone.
