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France’s election and global financial risks

The Macro View

Pile of euro coins on a chart

The French election is a game changer for global financial markets for multiple reasons. One: the worst case scenario of far right (Le Pen) and far left (Melenchon) as second round candidates for the Elysee Palace on May 7th is no longer a systemic risk. This was the reason the Chicago Volatility Index (VIX) plunged by an incredible 24% once Fillon and Comrade Jean-Luc conceded. This was the reason Société Générale, my preferred French bank to bet on a Macron win, surged an incredible 10% in one session on the Paris bourse. Like Sherlock Holmes’ dog that did not bark, the market’s euphoria was based on what did not but could so easily have happened.

Two: as the French OAT-German Bund political risk premium compressed dramatically, banks in Italy and Spain became a mathematical license to print money, as I had predicted in successive columns since March. France’s fragile banking system can no longer trigger capital flight from Europe and contagion risk.

Three: Fillon’s Gaullists (Les Républicains?) were humbled and Benoît Hamon’s Parti Socialiste (the party of Mitterrand and Léon Blum polled a pathetic 6%!), the twin political pillars of the Fifth Republic founded by the legendary General de Gaulle in 1958, both collapsed in this election. Something profound has happened in French politics if a 39 year old Enarque with no political party (Louis XIV was 39 too, though too dumb to be accepted at ENA!) and zero deputies in the National Assembly could be the next President of France.

Four: Mark Twain was right. History does not repeat but it surely rhymes. In 2003, Marine Le Pen’s odious Papa reached the second round before the French establishment held its nose and rallied around President Chirac. Fillon and Hanon have now thrown in their support for Macron, the next anointed republican monarch. This is the best possible scenario for the EU, the euro, the ECB and even the Swiss National Bank, who no longer has to brace for another 2012-style surge in the Swiss franc. A Greek debt deal is also now a slam dunk.

Five: President Macron on May 7th (it ain’t over till it’s over, Yoggi Berra warns us!) would greatly increase the prospect of Chancellor Merkel winning the German election in the autumn. After all, Berlin would no longer have to anchor a Eurozone on the brink of catastrophe, as could well happen if Le Pen wins the French presidency. Political risk will be less of a sword of Damocles on the financial markets once France is no longer the epicentre of systemic geopolitical risk in Europe, as it was in 1789, 1792, 1804, 1815, 1830, 1848, 1870, 1940, 1958, 1968, 1981, and yes, 2017! Vive la République (the fifth one since the Great Revolution, to be sure).

Macron’s acolytes in the Banque Rothschild may find it premature to reach for the monk Perignon and the widow Clicquot. The legislative elections in June makes it certain that Macron and En Marche will have to “cohabit” with a Prime Minister from the (hopefully) centre right. This could generate political and fiscal malaise in the heart of Europe – and, yes, resurrect the CAC-Quarante bears! Like Trump and Boris, Macron has scaled the political Mount Olympus via a movement, not a party.

The French election was a steroid shot for the value of euro dollar, now just below 1.0935 as I write. The euro has now completed the classic Fibonacci retracement of its losses since Trump’s election win last November 8th. I would not be surprised to see the euro retest its May 2016 high of 1.1610 (seems so long ago in the Stone Age before President Abu Ivanka!). Yet this can only happen when Macron wins the second round on May 7th and imposes his policies on the National Assembly this summer. So the real metric of risk I track is the French OAT–German Bund 10 year government debt spread, narrowed by 20 basis points since April 24th. Dr Mario Draghi will not accede to German, Dutch and Finnish demands for higher policy rates while positioning on the long euro trade is a bit crowded. This means the euro’s path higher will not be linear!

Currencies – Sterling can rise to 1.36 after the UK election

“England has no permanent friends and no permanent enemies, only permanent interests”. This observation by Victorian statesman Lord Palmerston to justify cynical imperial diplomacy applies equally to Theresa May and the Conservative party. The Prime Minister stunned the financial markets with her decision to call a general election in June, even though Downing Street had denied rumours she would do so. Mrs May knows that a snap election will enable her to increase the Conservative party’s majority in the House of Commons to at least 100 MPs. This electoral calculus has seismic implications for the sterling dollar exchange rate, cable. My call? Sterling rises to 1.36 after election day in June. Why?

One: London bookies put a 28% probability that the Tory majority in Westminster will rise to 100. Fine. This means Mrs May will finally win political legitimacy and votes – to secure a soft Brexit deal with the EU. The malign influence of the 50 odd “hard Brexit” Tory backbenchers on 11 Downing Street would be diluted. This means Britain will finally enjoy a stable Conservative government led by a Prime Minister who won a general election in her own right, not merely inherited it after David Cameron committed a political hara-kiri last June. This is sterling bullish.

Two: the EU divorce settlement will be more easily negotiated since it will no longer be held hostage by the virulent anti-Europe hard exit factions in the Conservative party who have engineered regicide in Tory politics so many times since Mrs Thatcher’s ouster in 1989. This scenario is sterling bullish.

Three: Britain can increase its fiscal spending after the election. Given elevated inflation risks after the 15% sterling fall after June 23rd, the Bank of England would accelerate its timetable for a rise in the money market policy rates. This is sterling bullish.

Four: Mrs May will insist on immigration reforms, border curbs and freedom from EU courts, as these are key Tory demands. Yet she could well compromise with the EU on trade and “passporting” rights for banks operating in the City of London. This means the risk of a breakdown in Brexit negotiations fall while the odds of a deal more favourable to the banking oligarchs of the Square Mile increases. This is sterling bullish.

Five: it made strategic sense to be bearish on sterling since at least the autumn of 2014. Now politics and monetary policy argues that it is insane to be bearish on the pound. The sterling bears will face the mother of all short squeezes as the structural short position in Planet Forex is assailed. This is sterling bullish.

Six: the Scottish National Party (SNP) swept every Scottish seat in parliament in the 2015 election. If the SNP loses Scottish seats to the Tories in June, the Prime Minister will gain the political capital to ignore Nicola Sturgeon’s call for a new referendum on an independent Scotland. This will be a reprieve for the fate of the United Kingdom and will defuse the uncertainty time bomb. This is sterling bullish.

Seven: the 2017 election will write the political obituary of the loony left leader of the Labour Party. Jeremy Corbyn is the Micheal Foot of our era, an unelectable asset for an incumbent Tory (lady!) Prime Minister. My advice to Mr Corbyn? You turn if you want to. This lady’s not for turning. Net-net, Labour could well lose 40 seats in June. UKIP? A sad joke. This is sterling bullish.

Eight: I am no expert on UK politics, but friends in London tell me the Tories will thrash Labour in the Midlands and the North of England while the Lib Dems pick up three to five seats in Southwest England and the Home Counties. Could Theresa May lead a government with 390 seats in the Commons? Yes, she can. This is sterling bullish.

The Macro View

About Matein Khalid

Matein Khalid

Matein Khalid is Chief Investment Officer of Asas Capital in the DIFC; he is responsible for global investment strategy and the development of the multi family office platform. He has worked in Wall Street money centre banks, securities firms and hedge funds in New York, London, Chicago and Geneva. In addition, he has been an advisor for royal investment offices in the Gulf for 8 years. Mr Khalid has four degrees in finance, economics, banking and international relations from the Wharton School, University of Pennsylvania. He is a director at the American College of Dubai and has taught MBA level courses in commercial/investment banking at the American University of Sharjah and British University of Dubai. He writes the Global Investing columns for Khaleej Times, Gulf Business and Oman Economic Review.

Articles by Matein Khalid

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