The Money Market Consequences of Madame Le Pen

Summary
       
• The fear of the far right is overrated. Markets have learned to live with the far right/populists in power: Trump in the US and Meloni in Italy. In fact: both received a standing ovation from markets: strong rallies. Not to mention many instances in small European countries where the far right gained power or even joined the government. The fact that no one even mentions the far right in small European countries speaks volumes.

• The real risk in France is the far left surprising at the elections. The left, which is still clinging to its signature policy of lowering the retirement age to 60, is much more likely to start a Greece 2015/Syriza-like clash against economic orthodoxy than the far right. Ahead of the first round of voting on June 30 (second round on July 7), the left alliance is closing in on the far right, which is still leading the polls.

• Fundamentals are overrated. It is a well-known fact that French government debt is on an unsustainable path. So is Italian government debt. Before the EU elections, no one cared. The bond vigilantes, if they still exist, have not disciplined President Macron for his fiscal recklessness.

• Unless we see a crisis-like situation in France (which I certainly do not expect, for what it’s worth), the money market implications of the recent turmoil in French markets are manageable. In my main scenario I envisage a measured increase in French Target2 liabilities and corresponding outflow of bank reserves. By the end of the year, the reserve ratio of the French banking system will still be at reasonable levels and above a key threshold.

• Italian, not French banks would be the biggest victim of persistent French political uncertainty. Without positive investor sentiment and thus further declines in Italian Target2 liabilities, Italian banks will increasingly need to resort to ECB regular refinancing to have satisfying levels of reserves. Demand for regular refinancing could rise at a quarterly rate of around 10 billion euros instead of around 5 billion euros that I have penciled in the fair-weather scenario. That would be reflected in (low) single digit increases in FRA OIS/Euribor OIS spreads.