Jean-Luc Melenchon

Problems With The French Left, Keep Potential For Le Pen Victory Alive

At the end of last week, bond investors were unnerved by news of a potential alliance between Benoit Hamon, the Socialist Party candidate, and the Left Party’s Jean-Luc Melenchon. Looking at the current polling suggests that a united Left-Socialist candidate could make it through to the second round of voting, coming just behind the Far Right candidate Marine Le Pen. This could actually increase the chances of a Le Pen victory as more right-leaning voters would likely either abstain or vote for Le Pen. Her agenda to leave the EU and abandon EUR would require Parliamentary approval and as such represents an unlikely outcome.

However, initial signs over the weekend suggest that such an alliance is precarious at best as Hamon and Melenchon trade insults and looked far from allies. However, the prospect of a co-operation between the two is not to be completely ruled out as there reports of a meeting between the two, scheduled to take place this week, but given recent events, an allegiance does seem unlikely.

This clearly keeps the tail risk of a Len Pen victory firmly alive. Current polling suggests that Le Pen will likely make it through the first then lose in the second round, by a significant margin, to either the centre-right candidate Fillon or the independent Macron. This scenario remains the most likely even in reference to Monday’s poll, published by OpinionWay, which sparked a further widening of French sovereign bond spreads over Germany.

Jean-Luc Mélenchon’s campaign, 2012. Image via Thomas Bartherote

If Macron came first or second in the first round voting, that could be enough to fuel a rally in French government bonds given the significant level of political risk premium that has built up. This is especially true for non-CAC bonds which are viewed as the most vulnerable to denomination risk on a French exit from the Eurozone. The potential for a hard left or a hard right French-President could weigh on future Franco-German co-operation, disrupting EMU policy for years. This would essentially leave control in the hands of the ECB, who might opt to buy time by extending the current regime of negative real rates and yields.

Renzi Leadership Battle Increases Italian Political Risk

Also over the weekend, we had the official resignation of former Prime Minister Matteo Renzi from his role as the head of the governing Democratic Party. This news has triggered a leadership election which will be held in April or May. Renzi is of the view that he requires a fresh mandate following his loss of the senate reform referendum last year and also in the face of rising left-wing opposition from dissidents in his party that view his policies as too centrist.

Although Renzi is likely to regain the leadership, this election could be the catalyst for a split in the party with some members leaving to form their own left-wing party. The latest poll released by Ipsos suggests that this could reduce support for Democratic Party by around 4 – 6 percentage points. The current gap between the Democratic Party and the Eurosceptic Five Star Movement is currently only around 3 percentage points so a split along the aforementioned lines, in the Democratic Party, could actually put the Five Star Movement in the lead heading into the general elections.

Whether the Five Star Movement would be able to form a government is partially dependent on the final shape of the electoral form of the lower house. Also, it is important to note that the timing of the next general elections is still uncertain though reports do note that Renzi is pursuing a September polling date, five months ahead of the officially scheduled timing which is February 2018. Growing political risk, as well as rising ECB tapering expectations, will present a difficult environment for Italian government bonds over the coming months, especially given the country’s poor economic backdrop.