By Shane Oliver

As suggested by opinion polls, the centrist pro-Euro candidate Emmanuel Macron will face far right anti-Euro National Front candidate, Marine Le Pen, in the May 7 run-off vote for President of France. 

With around 80% of the vote counted, Macron is on track to take 23.4% of the vote, with Le Pen on 22.6%, centre-right Francois Fillon on 19.9% and far-left Jean-Luc Melenchon on 18.9%. This is pretty much in line with recent polls and along with the Netherlands election, provides a vindication of them. 

This result is positive for investment markets, with the Euro up around 1.5% from Fridays close, as in recent weeks there was a fear that Melenchon would make the run off against Le Pen as both advocate policies that would threaten the Euro (albeit Melenchon a bit less so) and would be negative for the French economy (increasing state participation in the economy, deficit spending, more regulation, etc).

With all the talk about a populist/nationalist surge across Europe, supposedly on the back of the Eurozone public debt and migration crises, the Brexit and Trump wins, and Thursday's latest terrorist attack in France, the surprise for many may have been that Le Pen did not do better. In fact, poll support for her looks to have peaked at the tail end of the Eurozone crisis in 2013 when it got as high as 35%. 

Support for nationalists in Europe has been wildly exaggerated and the first round of the French poll marks the fourth election since Brexit - Spain, Austria, the Netherlands and now France - that has seen the nationalists do less well than expected. The majority of the French support remaining in the Euro and this works against nationalist extremists as was shown a few years ago in Greece where Syriza only attained power after dropping its anti-Euro policies and is now just another centrist European party. Perhaps also the Europeans have seen Brexit and the US election outcome and decided that’s not for them.

However, the French election won't be over until May 7. Macron's policies seek to strengthen the European Union, maintain openness and are mildly reformist for France - which would be good for the Euro and the French economy. However, Le Pen wants to re-establish the Franc for domestic transactions and allow the Bank of France to print money to finance deficit spending. Whilst her National Front won't win control of the National Assembly (parliament) in June elections, and so the new French Government will not implement many of her policies and a referendum to exit the EU and Euro is unlikely to pass given majority support to remain in the Euro, this won't stop French citizens and investors generally, from fearing that she will find a way to exit the Euro if she wins the presidency in the May 7 run-off. So, a Le Pen victory would likely see runs on banks (remember Greece in 2015), a surge in French bond yields relative to German yields and a renewed bout of Eurozone break up fears weighing particularly on the Euro and Eurozone shares but also on global shares as was the case back at the height of the Eurozone crisis in 2011-13.

Fortunately, Macron has been consistently ahead of Le Pen in polling for a second round run-off with the gap on the latest poll average well above 20%. This is far wider than the roughly 4 point polling error in the Brexit result and the 2 point polling error in the Trump-Clinton vote in the US Presidential election.

Source: Bloomberg, AMP Capital

That said, there is still a risk that things could go wrong and lead to a surprise Le Pen victory. A spate of IS terrorist attacks could drive support towards Le Pen (they are likely on Le Pen's side given that they thrive on extremism) or Russia could release hacked information damaging to Macron (via Wikileaks). And while it’s hard to see supporters of Melenchon or the Socialist Hamon supporting Le Pen, some of Fillon's centre-right supporters may switch to Le Pen rather than Macron. Fillon’s endorsement of Macron for the run-off may help minimise this though. Hamon has also endorsed Macron.

Moreover, with a majority of the French in favour of the Euro and highly negative to the far right National Front (partly for historical reasons) and the polling gap in favour of Macron in excess of 20% which is well beyond the standard error, our base case remains that Macron will win on May 7.

This would be a big positive for Eurozone assets. It would reinforce the impression that the populists are not winning in Europe. While some see the German election in September as a threat this is very unlikely as the contest looks to be between Angela Merkel and the Social Democrats under Martin Schulz who are even more pro Europe, with the nationalist Alternative for Deutschland polling very poorly. This, in turn, should help reduce Eurozone break up fears. While Italy remains a risk for next year, this all comes at a time when Eurozone assets are relatively cheap globally and Eurozone economic data continues to improve. All of which is consistent with retaining a large exposure to Eurozone shares. 

Source: Bloomberg, AMP Capital

For Australia, the outcome of the first round of the French election is unlikely to have a major impact beyond keeping in place the currently favourable global growth backdrop. That said, there is likely to be a mild relief rally in the Australian share market today and the $A has already had a 0.4% bounce against the $US reflecting its “risk on” status.