Marine Le Pen could 'blow up' the European Union, and the fear's starting to show

Changes in the French presidential race injected a little fear into markets there Friday.

France's left-wing politicians are gearing up for what promises to be a tough campaign against right-wing candidate Marine Le Pen.

Socialist Benoit Hamon and hard-left candidate Jean-Luc Melenchon held talks Friday about possibly joining forces to beat Le Pen and her Front National party. Opinion polls put support for the two men at levels which, if combined, could be enough to reach a May 7 runoff election between the two top-scoring candidates.

French bond yields ticked higher on the news. Yields move in the opposite direction of prices, and many holders of French debt fear Le Pen, who has said she will pull the country out of the European Union. But they apparently sold the bonds on fear that a unified left-wing front could — perhaps ironically — push the centrist vote toward Le Pen.

The difference between French and German 10-year sovereign debt rose to greater than 0.7 percentage points as French yields climbed.

"The spreads between the two are being driven by political risk from the election," said Diego Iscaro, senior economist at IHS Markit, a London-based research firm. If Le Pen wins, "I would expect these spreads to increase dramatically."

France's main stock market index, the CAC 40, was down 0.65 percent Friday.

Financial analysts were already keeping a close eye on the Continent this year, with elections in France, Germany, Italy and the Netherlands coming up and the future of the European Union potentially at stake.

It's important to note that a Le Pen victory does not make a French departure from the EU certain. But the election there merits closer monitoring than the other European contests, said Eric Adler, CEO of PGIM Real Estate.

"Whatever the outcome is in the other elections, it's manageable," he said Wednesday at an event in New York City. "The idea that Marine Le Pen could win could blow up" the European Union.

Le Pen wants to curtail immigration and has made headlines over the past year with her anti-European Union rhetoric, which echoes that of former Brexit leader Nigel Farage. A French abandonment of the EU would essentially mean the bloc losing its second- and third-biggest economies at the ballot box in the space of less than a year. Germany is the EU's largest economy.

In a November interview with CNBC, the leader of the Front National party said France has suffered "tremendous losses" in many sectors, adding it needs a strategic plan bring it back to its feet. Unlike the United Kingdom, France also uses the euro, and so would have to change currencies if it left the European Union.

French elections typically happen in two rounds. Recent polls show Le Pen winning the first round of voting, scheduled for April 23, but losing in the May 7 run-off vote between herself and whoever comes in second in the first round.

"Most polls suggest the Front National will lose the election," said IHS' Iscaro. "That said, polls have been wrong recently, so we have to take it with a pinch of salt."

Most polls about the Brexit referendum in the United Kingdom and, most noticeably, the U.S. presidential election were wrong.

Anxiety about Le Pen possibly winning the French presidency has troubled investors globally.

"If Le Pen wins, we're going to have a crisis within the euro," said Peter Cardillo, chief market economist at First Standard Financial in New York, adding that such a major disruption would further lift the U.S. dollar.

The euro has fallen 3.6 percent against the dollar over the past year.

Euro/dollar 1-year chart

Source: FactSet

IHS Markit's Iscaro noted, however, that a Le Pen victory doesn't guarantee France's departure from the European Union. Le Pen would need to garner enough support in parliament to call for a referendum and then people would have to vote in favor of leaving the single-currency bloc.

"Again, it's not impossible, but it's also not a done deal that if the Front National win, that France will leave," he said.

CORRECTION: A previous chart misstated the 10 largest European Union GDPs by including two countries that are not in the EU.