(Bloomberg) — French markets rallied and the euro gained on betting that Marine Le Pen’s National Rally was on the verge of winning the first round of France’s parliamentary elections by a narrower margin than some polls had indicated, making it less likely that the far right would secure an absolute majority.
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CAC 40 stock futures rose nearly 3% and the euro rose 0.6% to $1.0772, the highest level since mid-June. France’s 10-year government bond edged higher, narrowing the yield spread with German banknotes to 73 basis points, the lowest in two weeks. A gauge of European credit risk fell to its lowest level since June 13.
Initial forecasts showed Le Pen’s far-right party ahead of President Emmanuel Macron’s centrist alliance and the left-wing New Popular Front — but with possibly fewer votes than needed to win an absolute majority after a second round of polls on July 7 . That would slow down the legislative process and limit Rassemblement National’s ability to push through its policies.
Investors are concerned that a strong turnout for Le Pen’s National Rally would increase the chances of an expansionary fiscal policy, throwing the country’s bloated budget accounts into sharp focus and further clouding the outlook for the common currency.
“We now have a week of horse trading ahead of us,” said Joachim Klement, head of strategy, economics and ESG at Panmure Liberum. He expects the euro to strengthen during the week as alliances are formed to reduce Le Pen’s party’s gains.
What Bloomberg Strategists Say…
If the left-wing alliance “aims to prevent Le Pen’s group from gaining a majority in the crucial second round, it will have far-reaching consequences for the Franco-German divide and indeed the euro. If the result is that we get a more centrist government, that would be positive for the currency and herald a narrower spread.”
— Ven Ram, cross-asset strategist for MLIV
The National Rally is expected to get about 34% of the vote Sunday night, according to analysis by five pollsters. Bloomberg’s latest poll of polls on Friday put it at 36.2%.
The left-wing New Popular Front coalition would get around 29% and Macron’s centrist alliance between 21% and 22%, Sunday’s projections showed.
“The fiscal policies of both camps are disruptive to the French economy and the outlook for the French debt burden,” said Vincent Juvyns, global market strategist at JPMorgan Asset Management, referring to the National Rally party and the New Popular Front coalition. “For me, it’s a wait-and-see situation.”
Macron and Le Pen’s other opponents are already devising strategies to keep the far-right party out of power. Any sign of progress is likely to reinforce the need for an emergency meeting.
According to Kathleen Brooks, research director at XTB, the alliances being formed to keep Le Pen from absolute power appear credible, and the French market is likely to recover.
“A parliament without a majority could make it difficult to get anything done in France in the current parliament, which is exactly what the markets want,” she said.
Still, strategists warn that volatility is likely ahead, as the electoral calculus becomes complicated in the second round when parties may strategically withhold candidates in certain constituencies to boost a centrist hopeful.
Volatility is the only certainty for traders analyzing French results
Macron’s decision to call a snap vote in early June had sent markets into a tailspin.
His party – which backs deep spending cuts to control France’s budget deficit – suffered a crushing defeat in the European parliamentary elections. National Rally has since touted a series of costly fiscal measures, including a cut in sales taxes on energy and fuel.
Over the past two weeks, the extra yield investors demand to hold 10-year French bonds over safer German debt has soared to more than 80 basis points, levels last seen during the eurozone sovereign debt crisis. The euro fell to its lowest level since early May.
Fiscal pressure
According to Peter Goves, head of developed markets government bond research at MFS Investment Management, it is difficult to see a “material and sustainable rebound” in French yields.
“The uncertainties are great, the French fundamentals have not changed and the final outcome is still unknown and unknowable, as the large number of three-way matches complicates matters,” he said.
With an expected 5.3% of output this year, France’s budget deficit already far exceeds the 3% of economic output allowed under European Union rules. The International Monetary Fund predicts that without further measures, the debt will rise to 112% of economic output in 2024, and will grow by about 1.5 percentage points per year over the medium term.
–With assistance from Allegra Catelli, Julien Ponthus and Farah Elbahrawy.
(Updates market movements.)
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