French election: The far-right wins, but there’s a big test to come

The initial reaction to the first round of voting in the French Parliamentary election that took place on Sunday has been a small sigh of relief. EUR/USD has opened higher, and is up some 20 pips. Although Marine Le Pen’s National Rally party won the largest vote share, it was still short of an overall majority. Also electioneering in the aftermath of this first round of voting could thwart the ambitions of the Far Right. The Socialist Party has called for alliances ahead of the second round of voting next Sunday, to block Le Pen’s Far Right party from winning an outright majority and forming a government, something which has spooked French asset markets in recent weeks.

However, everything is still to play for, as many of the 577 French districts will now go to a second round run off next Sunday, which suggests that few candidates got over the 50% mark needed to eradicate a second round run off vote.

A leftist alliance could be a thorn in Le Pen’s side

President Macron and Socialist former French President Francois Hollande have touted the possibility of forming a political alliance, which may see Hollande form a left-leaning unity government in a bid to block Le Pen’s party from gaining an outright majority. Emmanuel Macron hinted that he could allow some candidates in his centrist party to step aside to allow left-leaning parties to win, in a statement on Sunday. However, there would be no concessions for the Far-Left parties, including the Unbowed party. Thus, Macron’s centrist party could step aside for the leftist popular alliance in order to block Le Pen from winning power, which is a market-friendly development. This makes the second round harder for Le Pen, since the Left leaning Popular Alliance came in second place to Le Pen’s National Rally, winning 28.5% of the vote. Alongside Macron’s Ensemble party’s 22.5% of the vote, the leftist alliance would have a credible chance against the National Rally.

Even the Hard Left La France Insoumise party has issued an instruction to all left-wing candidates in third place to withdraw from the race, as this could help to block Le Pen’s party in the second round of voting.

Le Pen still fails to win an outright majority

We shall have to see if this electioneering from the centrists and the left will actually put them in a strong position next week when the latest polls come out. According to Sunday’s vote, the far right could win between 230 and 280 seats in the French parliament next week, which would fall short of an outright majority, and could lead to a messy hung parliament.

However, even this would be a better result from the market’s perspective, compared to an outright win for the National Rally. The market was concerned that Le Pen and co. would add to fiscal pressure on France and adopt policies including lowering the pension age and taking a hard line on immigration, which could enlarge France’s current budget deficit of 5.5%. A hung parliament could make it hard to get anything done in France in the current parliament, which is exactly what the markets would like.

French stocks: Sell the rumour, buy the fact?

It's been a bruising month for French stocks, is now the time for a recovery rally? The Cac 40 is the weakest index in Europe so far this year and registered a half-year loss of more than 3% on a currency adjusted basis. In the past month since the election was called, bank stocks have sunk and were some of the weakest performers on the French index. Credit Agricole and Société Generale were the weakest performers in the index in June, and fell 20% each, which is correction territory. BNP Paribas also fell 12% last month. The markets were concerned about the amount of French debt that domestic banks hold, which could put them at risk if there was a big sell-off in French debt on the back of a win for Marine Le Pen. There was a lot of bad news already priced into French stocks, so, if we see the polls suggesting either a hung parliament or gains for the leftist alliance in the coming days, then we may see a recovery rally for French stocks.

The sell-off in French stocks was so forceful since the election was called that only two stocks rallied last month: luxury giant Kerring and Sanofi. They were protected from the sell-off due to their international exposure, with big losses for domestically focused firms, including Carrefour, down more than 13% and Vinci, down 14%. The next few days could be a binary outcome for French stocks: if support for the National Rally shows signs of breaking down in the next few days, this could spur a broad-based rally, but if support for the far right holds up, then stocks may stage another sell-off.

What next for the French- German yield spread

All eyes will be on French stocks at the start of this week. As it stands, the result was expected, but the alliances that could form to block Le Pen from gaining power are being formed right at this moment. If they start to look credible, then we could see French markets recover, and the French – German 10-year bond yield spread recover, after it blew out to nearly 80 basis points last week. If fears about a hard right government start to recede, we should see it in the French – German yield spread first.