Croissants and a Debt Crisis

The odds are improving that Marine Le Pen will become the next president of France. These odds are still long, but they were also long for Brexit and a Trump victory.

One of Le Pen’s most notable promises is to take France out of the Euro and redenominate the national debt into newly issued French francs. France would default on its sovereign debt if it unilaterally converted its euro-denominated obligations into new francs following a National Front election victory, Moritz Kraemer, S&P's head of sovereign ratings recently wrote. This is a big deal as there is close to €2 trillion of French national debt outstanding. Investors are starting to take this risk seriously, as evidenced by BlackRock (and others’) recent meetings with Le Pen’s party officials in order to take the measure of this policy plank and begin to analyze its ramifications.

The financial markets are starting to give some credence to this seemingly unfathomable outcome, resulting in a widening spread between the French and the German 10-year debt. This risk measure does seem to rise and fall on election poll numbers, the chart below suggests. To be fair, other measures suggest less worry, like the French stock market, which since last summer has continued to advance, and recent improving economic numbers from the European Union.

Additionally, much can happen between now and the election. The first round of the 2017 French presidential election will be held on 23 April 2017, and Le Pen is expected to be one of the two top candidates. Should no candidate win a majority, a run-off election between the top two candidates will be held on 7 May 2017. Even if Le Pen wins, there would be legislative and legal hurtles impeding any drastic currency decisions.

So why are French politics and the redenomination of French euro sovereign debt of interest to U.S. investment grade bond investors? Political tail events can and do impact interest rates and risk appetite in the United States, sometimes materially. Consequently, we continue to position portfolios conservatively in these interesting times – safe is good.

In the meantime, enjoy your morning croissant. Who knows, maybe breakfast will be cheaper on the morning of May 8th.

 Sources: The Financial Times, Bloomberg, The Economist