Soc Gen: French Election Focus
Tail risks fade as polls suggest Macron will be the next President:
WHAT THE POLLS SAY: Polls ahead of the second round on 7 May show Macron in the lead with 61.6% of the vote compared to 38.4% for Le Pen, offering a comfortable margin.
As illustrated in the chart below, Macron has a significant lead over Le Pen in the opinion polls ahead of the second round of the French Presidential election on Sunday 7 May 2017. To alter this outcome would require either polls to get it very wrong (judging from the first round results, this seems less likely), a very dramatic shift in public opinion, and/or an exceptionally low turnout rate amongst the Macron supporters. Lower than normal turnout is a risk given the 8 May bank holiday but, as we show below, for Le Pen to win based on what the average of the latest five opinion polls shows, just 56% of Macron’s voters would have to turn up compared to 90% for Le Pen. This is unrealistic and would imply a total participation rate of just 68%. A further important point to note is that Fillon and Hamon have already called on their voters to vote Macron in the second round
A good track record for opinion polls. France’s presidential elections draw far more voters than any other election in France and the turnout rate is usually close to 80% (77% for the first round according to the preliminary numbers), especially for the second round. On average, the turnout of the second round has been 81.6%, 1.4pp higher than the first round average. This helps explain why, historically, the opinion polls have so far never failed to accurately predict the second round winner.
Turnout would have to be exceptionally low for Le Pen to win. As illustrated in both the case of the UK referendum and the US presidential election, a differentiated turnout can make a big difference. For instance, if a specific group, be it by age or social group (generally measured in France by educational attainment), has an actual participation rate on the election day that differs significantly from past behaviour then opinion polls could be wide of the mark. In the table above, we have replicated the methodology developed by Cevipof (Centre for Political Research, Sciences Po and CNRS, cf Marine Le Pen can breach her glass ceiling: The drastic effect of differentiated abstention). The table shows different assumptions on voter turnout and voter preferences for the total electorate. For example, if the electorate has a preference at 61.6% for Macron and 38.4% for Le Pen (average of the latest five opinion polls), then if Le Pen’s turnout is 90% then Macron would still win as long as his turnout was at least 56%. Such a low turnout seems unrealistic: it would for instance require a doubling of the abstention rate of the citizens that support Macron and who have had a Baccalaureat or a higher degree.
Although the FX market has reduced short EUR positions and EUR/USD risk reversals are already less skewed to the downside, further EUR gains are likely ahead of the second round.
At the time of writing, it appears the opinion pollsters did a better job of predicting the first round votes in the French election than they did in the case of Brexit or the US presidential vote. That doesn’t mean we should be overconfident of the outcome in those second round, but as the US statistician and election analyst Nate Silver observed on Twitter, whereas Hillary Clinton led Donald Trump by 2-3pp and ‘Remain’ led ‘Leave’ by 1-2pp in the run-up to those votes, Emmanuel Macron leads Marine Le Pen by a whopping 26pp in runoff polls. Given that she hasn’t polled better in the first round than polls had suggested she might, and given the well-known challengers she faces to significantly boost her support between the first and second rounds, it would not be at all surprising for the FX market to start to price in ‘President Macron’ with a fair degree of confidence. Should that happen, the market focus will likely shift back to an improving French and eurozone economy, and to the prospect of further withdrawal of monetary stimulus by the ECB. That, in turn, would put Bund yields under upward pressure, and narrow interest rate differentials between the US and Europe along the length of the yield curve, in both nominal and real terms.
CFTC data for last week show a slight rebound in the (small) speculative EUR short in the futures market, but the striking feature of the relationship between positioning and the level of the EUR is the de-coupling we have seen since the US presidential election. In both 2015 and in the spring of 2016, a cut in short positions took EUR/USD to 1.14-1.16. The starting point is lower this time, and the election is most definitely not over yet, but the scope for a move into the mid-teens if Macron does win seems clear, and this week will likely see a step in that direction.
In the longer run, there are two variables that will determine the outlook for the EUR. The first is relative interest rates, and in particular longer date yield differentials, in both real and nominal terms. The current 25bp on 10y Bund yields reflects a lot of political uncertainty and may rise sharply. It also puts the 10y real yield at -1.05%. The more this moves, the more the EUR rallies. The second variable is what the election means for monetary policy and what that means for Europe’s balance of payments. We’ve written a fair bit about this in the past, but with the most updated data (for February released last week) we see a €362bn current account surplus in the last year being easily recycled as European investors buy a net €576bn in foreign bonds (Euro buying – foreign buying of European debt), but that number is now already down from a peak of over €720bn in the year to September. If reduced political uncertainty and a strengthening economy push the ECB towards a faster reduction in its bond purchases, European investors, who have been crowded out of European bonds and, in the process, dragged the EUR lower, would be slowly crowded back into European markets. The combination of QE and bond buying was the catalyst for EUR/USD to trade in its current 1.04-1.16 range, instead of the 1.20-1.40 range of the previous years.
Political volatility premium to collapse but not to disappear. Conjecture that Mélenchon might qualify for the second round (Google Trends) triggered a short-lived spike in EUR/USD 2w vol on Sunday. But the stress vanished with the projected results excluding a second round with two anti-European candidates, but including the market-friendly Macron, largely favoured by the polls to be the election winner. The option market premium for political risk started to ease over recent weeks, with 6m-1y risk reversals of euro crosses trading softer. The premium remained very high for the options expiring the Monday following the vote of each round. Our new SG FX-Event Tracker, which can be used to visualise how the perception of a political risk event changes over time, highlighted that the market priced a similar premium for each round. The outcome of Macron vs Le Pen coming out of the first round substantially reduces the political uncertainty, and the volatility market will start the week in a risk-friendly mood. Even if the EUR turns out to be very well bid and quite volatile, implied volatility should stay fairly contained. The recent EUR/USD realised volatility includes periods of high turbulence but is not that high, so that cannot justify the fact that the vol market is durably bidding the gamma. However, the political risk premium won’t totally disappear, as there will still be uncertainty concerning the general elections. Macron may struggle to obtain a political majority with his new political formation ‘En Marche!’. A scenario seeing some political uncertainty regarding the political support of the parliament cannot be ruled out. Afterwards, the option market should essentially shift all its focus to the ECB communication regarding tapering modalities.
TECHNICAL ANALYSIS: EUR/USD: remaining above the multi-year graphical level of 1.0860/1.08 will be key
Additional evidence that the pair has achieved a major trough at 1.0350, the down sloping channel support in place since 2015, is emerging. Indeed, the EUR/USD is breaking the crucial 1.0860/1.08 graphical barrier that represents the multi-year horizontal level (red dash line), the declining trend line from May 2016 and the 38.2% retracement of the following down move and, last but not least, the confirmation level of an Inverted Head and Shoulder pattern that formed at 1.0350.
Remaining above 1.0860/1.08 (daily closing) is therefore instrumental in the extension of the ongoing recovery towards the upper band of the short-term up channel resistance at 1.0985 and 1.1130, the 61.8% retracement of the down move and also last September/November’s graphical levels. 1.13, the 76.4% retracement and more importantly the projected potential for the aforementioned pattern, will be a significant objective.
Immediate supports are placed at 1.0860 and 1.08/1.0780, which are also the 23.6% and 38.2% retracement levels of the last bout of up move.
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