05/04/2017 08:51 BST | Updated 06/04/2018 06:12 BST

France Decides European Future

Following Brexit and Trump's victory in the US, many feared Europe would fall prey to Eurosceptic, nationalist, and protectionist populists. The coming French elections should be regarded as the most important populist test and the defining European political battle this year.

Open versus Closed

In France, politics has long been dominated by a left wing and a right wing party. This left-right political spectrum seems outdated. In the words of Marine Le Pen, now the patriots are fighting it out with the globalists; it's open versus closed. These new battle lines have added to the crisis of traditional conservative and social-democrat parties in many a nation.

In France, this is very obvious since the main candidates for the presidency - Le Pen and Emmanuel Macron - don't represent one of the established parties. Le Pen's National Front was founded by her father in the 1970s. Jean-Marie Le Pen is a xenophobe with a history of anti-Semitism. Marine has tried to steer a course that would make her party more palatable to mainstream voters. And she has been quite successful at that.

Macron's path to being a presidential candidate is another story. He has been a banker at the Rothschild bank and was a minister in Hollande's administration before he decided to form his own movement. Macron is the market's darling since he aims to address the structural deficiencies that have been holding back the economy for years.

Uphill battle for Front National

France is in dire need of a Macron. The jobless rate is 10% while almost 24% of the youthful unemployed are looking for work. The national debt is approaching 100%, private indebtedness equals 229% of GDP, and industrial production is lower than it was in 1990. Among the prosperous countries, only Italy registered lower income growth per capita since 1990.

Macron is still the favourite in the race. The voting system consists of two rounds (unless one of the candidates were to gain over 50% of the votes straight away). Most of the supporters of the candidates who will probably drop out of the first round will not vote for Le Pen in the second round.

The presidential electoral system is not the only obstacle that will block major successes for radical parties. Front National has just two of the 577 seats in the National Assembly (the lower house) and two of the 348 Senate seats. Le Pen's party is only well-represented in the European Parliament where it has 24 of the 74 French seats. The party is due to score additional seats during the parliamentary elections in June but nobody expects it to even come close to the conservatives and socialists.

Don't count out Le Pen

The Front National may get all the attention, but it is unlikely to gain the presidency, let alone win the parliamentary elections. Yet, I am hesitant to rule out a victory for Le Pen:

> A terrorist attack could swing voters to Le Pen.

> Violence in the banlieues would also play into the hands of Front National. Many underestimate the level of anger in the country's troubled banlieues, which risks sparking an explosion of violence.

> In this day and age, we can't rule out outside interference in the elections. Especially since Le Pen enjoys good relations with Putin's Russia.

> Macron could get in trouble if Le Pen succeeds in framing the presidential election not as a choice between Le Pen or no Le Pen but as a vote over globalisation. In a study of six countries, the French were the most negative of globalisation, with 50% believing a more interconnected world has had a negative impact on France, compared with 39% who saw the effect as positive.

> Another of Macron's weak spots is his association with the very unpopular Hollande presidency. After all, he served as Minister of the Economy, Industry and Digital Affairs under Hollande.

> If many French abstain from voting, this would benefit Le Pen. Le Pen supporters are much more likely to vote than Macron supporters or many of the people backing other candidates.

Market implications

The above doesn't mean that I put my money on Le Pen. I just want to point out that most analysts are a bit too sure about Le Pen losing. That means the risks are on the downside from a financial market's perspective. If Macron becomes the new president, markets will probably react with some relief, meaning a somewhat stronger euro, downward pressure on credit spreads between French and German long-term interest rates and edging up of European stock markets. However, a Le Pen victory will cause much more volatility since it would be a major surprise and would be interpreted by many as an existential threat to the euro and the EU.