Meet the French presidential candidate who is even scarier for investors than Marine Le Pen

Key Points
  • Jean-Luc Melenchon, a communist, is rising in presidential polls
  • An admirer of Hugo Chavez, Melenchon has anti-EU tendencies
The French election is far from over as another candidate makes headlines
The French election is far from over as another candidate makes headlines

Marine Le Pen has dominated the headlines throughout the French presidential campaign, but another candidate is knocking her from the headlines: Jean-Luc Melenchon.

The communist Melenchon's polling numbers have skyrocketed over the past month, giving far-right Le Pen, conservative Francois Fillon and centrist Emmanuel Macron a run for their money.

It's not only France's future that's at stake, but possibly the European Union's. Both Melenchon and Le Pen have indicated they are willing to take the country out of the political-economic partnership.

A French abandonment of the EU would essentially mean the bloc losing its second- and third-biggest economies at the ballot box in less than a year. Germany is the EU's largest economy; the United Kingdom is the second-largest and it's already leaving the EU.

"This election is unusual. Usually, we have two candidates who are pro-European and no extreme parties," Philippe Ithurbide, global head of research, strategy and analysis at French asset manager Amundi, said in a media call Thursday.

The biggest concern for the IMF and World Bank?  France
The biggest concern for the IMF and World Bank? France

Melenchon, a self-proclaimed fan of late Venezuelan dictator Hugo Chavez, was polling at just 10.5 percent on March 17, according to French polling firm Ifop. As of Wednesday, however, he had climbed to 18.5 percent, just 1 point below Fillon and 4 and 5 points behind Le Pen and Macron, respectively.

"If you look at the timeline of his surge, it follows the first presidential debate," said Jeremie Cohen-Setton, research fellow at the Peterson Institute for International Economics. "He performed very well there."

Melenchon faced off against his three opponents for the first time on March 20. Reuters reported that a snap poll following the debate showed 20 percent of viewers found Melenchon to be the second most convincing candidate, after Macron.

Most polls, however, still show Le Pen and Macron as the favorites to move on to a likely May 7 runoff election between Sunday's top two vote-getters.

To be sure, polls heading into last year's Brexit vote and the U.S. presidential election were mostly wrong, causing shockwaves across financial markets when the results became apparent.

'Worst-case scenario:' Le Pen-Melenchon runoff

Several scenarios could play out in the first round, but Cohen-Setton said a second round faceoff between Le Pen and Melenchon would be the "worst-case scenario."

Le Pen has said outright that she'd move to have France leave the EU if elected. Melenchon is willing to keep France in the EU but only if the whole bloc becomes willing to enact his fiscal reforms and have the European Central Bank answer to political interests rather than purely monetary ones.

Jean-Luc Mélenchon surges in presidential race: Polls
Jean-Luc Mélenchon surges in presidential race: Polls

Melenchon would move to have France leave the EU if his proposals fail. For France — unlike the United Kingdom — leaving the EU means also leaving the euro zone, which is the part of the EU that uses the euro currency.

"That's not something we know much about, except it will be very messy," Cohen-Setton said.

"I think that's the part that's very critical," Cohen-Setton added, "whether it opens the door for a single-currency exit."

Melenchon has also said he would take France out of NATO.

He says he would tax French citizens who make 400,000 euros a year or more at a rate of 100 percent.

Presidents can't ditch EU on their own

Despite their anti-EU beliefs, Le Pen and Melenchon would have to shore up support in the French parliament — as well as hold a referendum on EU membership — before France can even begin the "Frexit" process, making the event less likely to occur.

Investors have been holding their breath ahead of Sunday's contest. France's CAC 40 stock index on Tuesday posted its worst one-day performance since Sept. 26 as jitters over the election led investors to sell ahead of the contest, though it reclaimed ground on Thursday.

French bond yields have risen recently as investors dump the country's debt in favor of more steady German sovereign bonds. The spread between the French and German 10-year yields hovered around 70 basis points, near its highest level since late February.

"If we have Melenchon and Le Pen advancing, we could see the spread widen significantly, maybe around 150 to 200 basis points," said Diego Iscaro, senior economist at IHS Markit.