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French elections – which markets to watch?

The outcome of the French election has now become more uncertain, and we look at key markets to watch.

All trading involves risk. Losses can exceed deposits.
Eiffel tower
Source: Bloomberg

It wasn’t supposed to be like this. The script for the French election previously ran as follows: Marine Le Pen has a strong showing in the first round, perhaps even coming first, while a centrist candidate, either Emmanuel Macron or Francois Fillon (probably the former), is the other candidate to go through to the second round, to be held on 7 May. Le Pen would then be defeated as French voters rallied around the centrist, preventing the Front National (FN) from ascending to the presidency.

Now, the polls are showing a strong performance by leftist candidate Jean-Luc Melenchon, with the margin of error suggesting that Fillon, Le Pen, Macron and Melenchon each have a shot at being one of the two to go through to the final contest. This is beginning to cause jitters in the market, as the spread between French and German 10-year bonds hits a seven-week high. What was supposed to be a predictable contest may now be blown open. Haven’t we been here before?

Both Le Pen and Melenchon want to put France’s euro membership to a popular vote, and both are opponents of the EU project, at least in its current form. A possible French exit from the single currency, and potentially even the EU, will likely destabilise markets, at least in the short term. The lesson of Brexit and of Trump is that we should not get too apocalyptic in our predictions. Even if one of these two ‘fringe’ candidates were to win, it would be difficult for them to put their manifestos into practice as complex constitutional changes cannot be enacted by presidential fiat. They require the approval of both chambers of the French parliament, in which neither the FN or Melenchon’s party La France Insoumise (FI) have majorities.

Still, the lesson of 2016 is that unlikely outcomes can never be discounted. A victory by either Melenchon or Le Pen would likely cause tremors across financial markets. The euro, for example, would likely face a downward move against the US dollar, as investors buy up the US currency, and Treasuries, as a safe haven move against volatility. Stock markets in the eurozone, which often receive a boost from a falling currency, may instead suffer again as money flows move to the UK or US.

Gold would be another one to watch here – the classic flight-to-safety trade would likely be reignited by a shock victory of Le Pen or Melenchon. Normally in a world of rising economic growth, gold would be out of favour but a win for an outsider could be just the thing to get gold moving sharply higher once more.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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