LONDON: French bond futures slipped, the euro dipped and European stock futures were little changed as traders digested initial projections in France’s legislative elections that pointed to a surprise victory for the leftist alliance.
Government bond futures fell 26 ticks in early Asian trading, the common currency was down 0.2% to around US$1.0821, while Euro Stoxx 50 Index futures were steady.
The left’s success has shone the spotlight on its campaign for a sharp increase in government spending.
Initial projections showed the New Popular Front (NFP), which includes the Socialists and far-left France Unbowed, is poised to get between 171 and 205 seats in the National Assembly.
Marine Le Pen’s far-right National Rally (RN), which had been expected to win the most seats, is seen coming third, after President Emmanuel Macron’s centrist alliance.
While money managers have spent the last week or so fretting over a Le Pen-dominated government, the left’s success will likely still concern markets, given that it amounts to a fresh dose of uncertainty in the eurozone’s second-largest economy and because the cohort is committed to a broad easing of financial policy.
That would exacerbate fears over France’s already-bloated balance sheet and put the nation on a collision course with the European Union, which is already taking action to curb the budget deficit.
“French politics confounds yet again,” said Geoffrey Yu, senior strategist at Bank of New York Mellon. “Based on the results, the risks of expansionary financial policy remain.”
Still, the left alliance is unlikely to win an absolute majority, potentially limiting how much it can do, and some strategists suggested a hung parliament would be a positive outcome for investors.
French markets plunged into a tailspin in June, wiping out billions of euros from stocks and bonds as Macron’s snap poll prompted concern that the far-right would take power.
But over the past week, traders pared a chunk of those losses as opinion polls indicated that the RN would fall short of an outright majority.
Last week, France’s CAC 40 Index erased about half of the losses it endured in the aftermath of Macron’s announcement.
The picture painted by initial projections on Sunday was very different. Macron’s centrist party, favoured by investors, was on track for second place, despite a poor showing in the first round of voting.
The outcome could leave the president in a position to cobble together a centrist coalition.
Still, the inevitable political wrangling and anxiety about the influence of the left within a hung parliament could push up the yield on the nation’s 10-year debt, known as OATs, pushing the spread over safer German bunds wider once again.
That spread had eased to close at 66 basis points last Friday, after rocketing to more than 80 basis points last month, levels last seen during the eurozone’s sovereign debt crisis.
According to James Rossiter, head of global macro strategy at TD Securities, the “shocking result” could easily send the spread back above 80 basis points.
“Rates markets went into the elections with the OAT versus bund spread pricing in a scenario for a hung parliament, but a hung parliament led by RN, not NFP,” he wrote in a note.
“Already, the French far-left leader said he would implement his entire programme and that he is unwilling to enter into any deals with Macron.
“That tone of defiance will hardly sit well with French bond investors.”
An absolute majority for the left was identified by investors as the scenario they were most concerned about in the days ahead of the first round of votes.
But that possibility was discounted after Le Pen’s National Rally convincingly won the first round.
Among its pledges, the left coalition wants to reverse seven years of pro-business reform and hike the minimum wage.
To implement its policies, the leftist NFP would require nearly €95bil (US$102bil) in extra funds per year, six times the spending planned by Macron and his allies and almost double that proposed by the RN, think tank Institute Montaigne said before the vote.
France is already grappling with a budget deficit that, at 5.5%, far exceeds the 3% of economic output allowed under European Union rules.
The International Monetary Fund predicted that, without further measures, debt will rise to 112% of economic output in 2024 and increase by about 1.5 percentage points a year over the medium term.
S&P Global Ratings downgraded France in late May, highlighting the French government’s missed goals in plans to restrain the budget deficit after huge spending during the Covid pandemic and energy crisis.
Vincent Juvyns, global market strategist at J.P. Morgan Asset Management, said tensions were likely with reforms spearheaded by Macron now in doubt, potentially hurting the value of French bonds versus their peers.
“Markets may demand a higher spread as long as the new government hasn’t clarified its financial position,” he said. — Bloomberg
