Markets rally on bets Le Pen will fall short in French second round

The first round of the French election showed that Marine Le Pen’s far-right National Rally (NR) Party may not be able to secure enough votes for an absolute majority, increasing the possibility of a hung parliament. The outcome buoyed the euro, with the single currency opening higher against most other G-10 currencies during the Asian session on Monday, as investors were relieved from the severe economic and political disruptions that could have ensued if Le Pen’s party had won a monopoly on power.

A possible hung parliament

Over the weekend, voter turnout in the French election reached 59.4%, compared to 39.4% two years ago, marking the highest turnout since 1986. According to projections from the first round of voting on Sunday, the far-right National Rally (NR), led by Marine Le Pen, won between 33% and 34.2% of the national vote. The left-wing coalition followed with 28.5% to 29.6%, while President Emmanuel Macron’s centrist alliance garnered between 21.5% and 22.4% support. 

The potential outcomes suggest that the NR could secure between 230 and 315 seats, the New Popular Front between 115 and 200 seats, and Macron’s centrist alliance between 60 and 120 seats. This marks the first time in history that the far-right has gained such political power in France.

However, Le Pen’s party still falls short of gaining an absolute majority to dominate the National Assembly, making it difficult to pass legislation. While this might create a precarious moment for the French political landscape, the second-round election due on 7 July will determine the country’s future. If the NR cannot secure enough seats to gain absolute power in the parliament, inter-party deal making in the runoffs will be critical for the outcome.

Nonetheless, this might be the best outcome for the European markets and the euro, as the French far-right did not gain as much support as projected. A scenario of a hung parliament means that no single party can override the legislative power, posing less threat to France’s financial stability. It will also give Macron time and an opportunity to make a turnaround in the next election in three years. 

European markets end June lower while volatilities ahead

Major European stock markets finished June on a negative note due to the political turmoil. The selloff was particularly pronounced in French equities, with the CAC 40 tumbling 6.42% last month. The Euro Stoxx 600 fell 2.08%, and the DAX was down 1.42% in June. Consequently, the euro weakened against most other G-10 currencies due to the rising far-right power in the EU parliamentary elections. Amid the uncertainties surrounding the final outcome of the French election, both European equity markets and the euro are expected to remain volatile in the week ahead.

Risk aversion may continue to dominate market sentiment, as evidenced by the spread between French 10-year bond yields and their German counterparts surging to 81.1 basis points again on Friday, the highest level since 2012. During times of crisis, German government bonds are considered safe-haven assets in Europe, leading to an increase in the yield spread between these two countries’ benchmark bonds.

French government bonds sell-off

Simultaneously, investors appeared to be selling off French government bonds amid concerns that the rise of the far-right party could potentially impair France’s ability to manage its public debt. Marine Le Pen’s platform advocating anti-immigration policies, tax cuts, and a reduction in the retirement age is expected to significantly widen the government deficit.

There are also concerns that the potential economic turmoil may have a ripple effect across the wider Eurozone. Last week, the German government halted a joint issuance of government debt aimed at supporting the defence system due to the political turmoil in France. Additionally, the rise of far-right influence could deter foreign investment and hinder France’s technological progress within Europe, posing risks to Emmanuel Macron’s ambitious plan to attract up to €15 billion in investments, particularly in technology, artificial intelligence, and pharmaceuticals.

Despite the increasing risks in France, the ECB does not deem it necessary to intervene in the French bond market. Lawmakers have emphasised that resolving any turmoil in the French markets primarily falls within the purview of French politicians.