Markets breathed a sigh of relief today as the moderate centrist candidate Emmanuel Macron qualified for the second round of the French presidential election in two weeks, together with the far-right anti-establishment candidate Marine Le Pen. While the result was expected, the prospect of a “left tail” outcome in which Le Pen significantly outperformed expectations had been a clear overhang on European assets. As evidenced by today’s reaction, this overhang has at least temporarily lifted, but longer-term we think caution is still warranted.
Breaking with the theme of last year, polls proved to be largely accurate, with Macron gathering around 24% of the votes and Le Pen 22%. The risk that markets worried about was that polls were inaccurate, as Macron only recently entered into politics and respondents may have felt shy in admitting their support of Le Pen. Ultimately, that risk did not materialize.
With polls indicating Macron in the lead over Le Pen by more than 20 percentage points in a direct run-off, and other mainstream candidates now voicing their support for him, it appears that Macron will win comfortably in the election’s second round on May 7th. Absent an unexpected shocking event of some sort, the new French president should be a moderate candidate.
As one would expect, markets are trading in clear risk-on mode today. Sectors that had been particularly weighed down by the risk of a strong Le Pen performance, such as European equities and financials, have seen a sharp relief rally – something we’d expect to play out further in coming weeks. However, while we agree that the weekend’s results reduce the likelihood of near-term left-tail risks in Europe, we continue to recommend caution in taking risk in the region given lingering political uncertainties extending well beyond France, and fairly unattractive valuations in fixed income assets.
Nicola Mai is a PIMCO portfolio manager and leads sovereign credit research in Europe. Philippe Bodereau is a portfolio manager in London and global head of financial research. Eve Tournier is head of pan-European credit portfolio management.