The hesitation waltz

In the weeks leading up Donald Trump’s election, traders had their eyes glued to the Mexican peso whose value lost or regained ground as the voting forecasts for the outsider candidate rose or fell. Now that the fervour has crossed the Atlantic and taken over France, it is now the “French-German spread” i.e. the spread between German and French government bond debt with the same maturity – on which eyes are riveted.

In 2016, this spread remained within a reasonable range of around 35 basis points. Mario Draghi’s asset purchases and vigilance have ensured sufficient controls to ward off any inclinations for increasing spreads. However, the surprise outcome of the US election has disrupted this balance. If the Americans could elect Donald Trump, then why couldn’t the French elect Marine Le Pen? Her regularly repeated threat to exit the euro provides more than enough reason for markets to worry. “France’s spread is rising” is rapidly becoming a favourite figure of speech of traders…

In early 2017, the fake job scandal involving the wife of the French presidential candidate, François Fillon (Pénélope-gate) has accelerated this process. The focus of market players on this spread has become an obsession: it is no longer necessary to refer the “French-German spread”. The term “spread” by itself suffices. An indicator that is rising and falling at the whim of French national political pronouncements: the possible alliance between Benoît Hamon, the new left-wing socialist candidate, and Jean-Luc Mélenchon, a candidate for the far left widened the spread to nearly 80 basis points… only to contract by 5 basis points when the centrist political figure, François Bayrou, announced his support for Emmanuel Macron. The more mischievous commented that this would be the first time that French centrist François Bayrou had any impact on financial markets.

It is thus worthwhile to take a step back: in the early 90s, France was perceived as a significantly higher risk than Germany. The transition to the euro zone, followed by its creation contributed to a situation of considerable stability for the spread that remained around 0.15%. The 2008 financial crisis, followed by worries about the breakup of the euro zone at the time of the Greek crisis, subsequently succeeded in disrupting this mechanism– with a peak of 190 basis points in November 2011. Even at 60 basis points today, the current value of the “France-Germany” bond spread is far from integrating an Armageddon scenario. To the contrary, and in line with the odds calculated by the bookmakers, financial markets put the probability of the far-right candidate winning the election at around 25%;

What would happen in this case? Without taking the exercise of political fiction too far, we would probably see massive flight of investors from French debt under the banner of Marine Le Pen. The European Central Bank would no doubt manage to limit the spread in the short-term. However its effectiveness would be seriously challenged by the election of a president having publicly announced her wish to exit the euro.

While this now is not the most likely scenario, it still must be taken into account in the management of our FCP mutual funds. Except in the scenario in which the candidates of the far right and far left suddenly collapse, investors will continue to feverishly monitor the temperature of the stock market thermometer until May. They would nevertheless be advised to keep in mind that antibodies and other natural defences available in the world in which they live are continuously working in the background. To be sure, when our new political reality has been established, the fever will fall as quickly as it came. Let us take advantage of these events to maintain our strategy as a long-term investor guided exclusively by common sense and clear-sighted search for the potential of companies.

“And yet it does move.”*

Didier Le Menestrel

* “E pur si muove !” is the phrase that Galileo was said to have whispered on 22 June 1633 after having been forced by the Inquisition to abdicate his theory that the earth revolved around the sun.