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Is the end of political uncertainty really a catalyst?
Almost 9 months of political uncertainty preceded the Presidential elections in France, driving asset managers to adopt the popular strategy of maintaining large cash weightings, combined with occasional short term trades in place of longer term positions. In the recent past, when the political dangers forecast actually materialised, they had little impact on the market given the high cash holdings in portfolios and in the financial system (mostly due to the ECB). We wonder what consequences the French vote will have in the light of the fact that it, alone, has gone in the markets’ favour.
 
It would be easy to assume that the French/German spread will continue to narrow, that risky assets will become more attractive to investors, and that the Euro will make up lost ground against the USD or the GBP and Nordic currencies. But, we suggest that these scenarii may already have been played out between the two rounds of the French elections. Is there any further upside in these trades?
 
Contrary to other recent political events, such as Brexit, the US election and the Italian referendum, the French election was broken into two segments. After the preliminary vote, various new polls and a low quality debate provided clues as to the likely outcome and the financial markets adjusted as a result, in advance of the second round.
 
After the first round of voting, we witnessed: 1/ the French/German spread tighten to 37bps, the lowest level in 6 months, 2/ the Euro flirt with $1.10, and 3/ two weeks of stock gains equivalent to several decades of French growth.
 
So, it is likely that the Macron victory, contrary to the other recent outcomes, will follow the adage “buy the rumour, sell the news” and that in the coming days we will see the unwinding of trades in French bonds, stocks and the Euro. This could provide an excellent opportunity for those who, over the past few days, had the brilliant idea of buying options while European volatilities were at historically low levels, to close the performance gap relative to competitors.
 
We note, however, that whist the financial markets may have already taken advantage of reduced political uncertainty in Europe, the French vote is positive news for the economy and could lead to increased investment by corporates in the coming months. CEO jitters, especially French, would have been a significant barrier to high quality results over the next few years and, hence, for credit quality and/or profitability and competitiveness.
 
Only the British have cause for concern as President-elect  Macron painted himself as a hard-Brexiter, as he believs that Europe has more to gain than the UK from a quick, final exit, without concessions. We have noticed the change in tone in the UK press which, after the first round of the election, seemed overjoyed by the potential for France’s troubles and the potential for a weakening in the French/German alliance with the rise of pro-Brexit and pro-Frexit parties. Today, they barely mentioned the result of the election, and some preferred to feature a photograph of Prince Harry and his (rumoured) new fiancée on the front page. “Fair play” is an English concept that these newspapers have arguably forgotten. We in France, and those in the rest of Europe, can but congratulate the provocative tabloids for their bitter-sweet quotes and analyses after the election results.
 
In relation to investment portfolios, keep an eye on the GBP and UK-based issuers, especially the banks, who may see a flurry of sellers reacting to Europe’s bolstered position relative to the UK.
 
In the credit market, earnings season is in full swing and we have seen strong results from many European companies which had run into difficulties of late, such as Vallourec, Outukumpu and Air France.
 
Last week’s most significant event, however, arose in the Financials sector, where Credit Logement managed to make an arrangement with the French regulatory authorities (ACPR) not to exclude completely its perpetual bond from the calculation of capital ratios as of 2021, as would have been the case otherwise. If this Tier 1 debt were totally excluded, the financing company would be very likely to call the bond in 2021. Owing to its low coupon (Euribor +115, currently about 0.80%, for a perpetual bond), its reintegration into Tier 2, however, affords Crédit Logement the possibility of maintaining the bond for a long time. The news was totally unexpected and the bond lost more than 4 figures when it was announced. It is true to say that it depended on an interpretation of the prospectus and a decision by the ACPR. Beyond the purely technical character of the bond, we recall that most financial bonds, especially subordinated, carry major regulatory risks. The prospectuses for former Tier 1, new Tier 2 or Cocos provide for numerous different outcomes, which may end up favouring bondholders or issuers, depending on the ever-changing regulations, which change under the seal of the ECB or the European Commission. We note that, on the strength of 1/ injections of liquidity from the ECB and 2/ the current bond market, banks and insurance companies relatively at peace. If, however, there were the slightest upheaval – economic, financial, or political – regulators could step in fast drawing up new regulations so that creditors would find themselves caught up in “bail-in” measures. So, we are not totally unconcerned … this, indeed, is the reason for which bank bonds are trading at a premium against their corporate peers which are less often caught up in changing regulations.


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