Far-Right Misses Expectations, French Markets Rebound!
On June 30th local time, the first round of voting in France concluded, with the second round scheduled for July 7th.
The results of the first round indicated that the far-right party, National Rally (RN), secured the first place with 33% of the support. The left-wing coalition "New Popular Front" (NPF) garnered 28.5% of the votes, ranking second; French President Macron's ruling party, La République En Marche (LREM), along with the centrist alliance "Ensemble", received 22% of the votes, placing them third.
The French National Assembly elections are held every five years. Following the ruling party's disastrous performance in the previous European Parliament elections, Macron announced the dissolution of the National Assembly on June 9th, calling for early elections for a new National Assembly.
However, as the National Rally's lead was not as significant as previously indicated by polls, the French stock, bond, and currency markets rebounded simultaneously on Monday during the Asia-Pacific trading session. Nevertheless, with the expectation of a likely hung parliament, market participants remain concerned that the final outcome could lead to extreme scenarios ranging from "political paralysis" to a "debt crisis."
Advertisement
French stocks, bonds, and currency rebounded on Monday
Since Macron announced the early elections, the French financial markets have been in turmoil: in the stock market, nearly $200 billion of market value was wiped out from the French stock market, with the CAC 40 index tracking blue-chip stocks reaching a low not seen since January, Société Générale and BNP Paribas fell approximately 19% and 11% respectively in June. Investors have increased their bearish option positions on the European blue-chip stock index to hedge potential losses, with the volume of bearish options reaching the highest in two years. In the bond market, French sovereign debt faced the most severe sell-off since the European debt crisis, with the 10-year French bond yield rising to the highest level since November last year, and the spread with German bonds once widened to 86 basis points, a new high since 2012. Currency market volatility intensified, with foreign exchange traders buying derivatives at the fastest pace in 15 months to hedge the risk of the euro's decline.
However, as the National Rally's advantage in the first round was not as large as indicated by previous polls, the euro, European stocks, and bonds all rebounded. During the Asia-Pacific trading session on Monday, the euro rose by 0.43% at one point, reaching a nearly two-week high of $1.0758. However, the euro has still fallen by about 0.8% against the US dollar since Macron announced the early election on June 9th. The Euro Stoxx 50 index futures rose by 1%, and French bond futures also edged higher.
Carol Kong, a foreign exchange strategist at the Commonwealth Bank of Australia (CBA), stated that the National Rally's performance was actually slightly worse than expected, "As a result, we have seen the euro rise slightly in the Asian morning session, as if the far-right party performs a bit worse, our concerns about more expansionary and unsustainable fiscal policies may actually decrease."
Joachim Klement, Head of Strategy, Accounting, and Sustainability at Liberum Capital, said, "There will be a lot of bargaining in the coming week." He expects that as various parties form alliances to reduce the National Rally's advantage, the euro will strengthen this week. If the parties can ultimately prevent Le Pen's National Rally from gaining a majority in the crucial second round of elections, France will have a more centrist government, which would be beneficial for the euro and would narrow the French-German bond spread.
Chris Turner, Head of Foreign Exchange Research at ING Bank, added that, in fact, the euro has stabilized in recent days because the National Rally itself has also started to say some "right things" to appease the market, realizing that negative market reactions would undermine their chances of success. However, he still warned that the 7 billion euros in tax cuts planned by the National Rally could still only be raised by reducing France's contribution to the EU budget. Therefore, the euro will continue to have bearish momentum.Markets Worry About Second Round Election Outcomes
Since no candidate received more than half of the votes in the first round, all candidates with a vote share of at least 12.5% will proceed to the second round, with the highest vote getter being elected. The market's focus now shifts to whether the National Alliance can secure a majority of support in the second round. The market expects that it is more likely for the National Alliance to win, but ultimately fail to secure an absolute majority of at least 289 seats, leading to a highly divided National Assembly and a period of political and economic uncertainty or stalemate following the election.
Many analysts are concerned that France may face a debt crisis, as either a far-right or left-wing victory would amplify the risk of France implementing expansionary fiscal policies in the future, further increasing the risk of France's large fiscal deficit. At the end of May, S&P Global Ratings downgraded France's credit rating, and the International Monetary Fund (IMF) expects France's deficit to be far above the EU's 3% of GDP limit in the coming years.
David Zahn, European Fixed Income Head at Franklin Templeton, told Yicai reporters that France's deficit has already exceeded the EU's prescribed limit, and the strong performance of far-right or left-wing forces indicates the possibility of France further relaxing fiscal policy. Therefore, investors are most worried about France falling into a debt crisis.
Holger Schmieding, Chief Economist at Berenberg Bank, also warned that if France's politics and economy fall into a stalemate, it could reduce France's long-term growth rate, continue to widen the interest rate spread with German debt, and lead to a "globally worse reputation." At the same time, a government dominated by a far-right or left-wing alliance could trigger more dramatic outcomes. Any side's "profligate agenda," including lowering the retirement age and cutting income taxes, could lead to an "imminent financial crisis."
The National Alliance has recently abandoned some extreme measures, claiming it will implement a "reasonable" spending plan to keep the deficit at the EU's 3% limit. However, Mohit Kumar, Chief Financial Economist for Europe at Jefferies, said, "France's current deficit as a percentage of GDP is 5.5%, and the debt as a percentage of GDP is 110%. This means that whoever wins, it will be very difficult to reduce France's deficit in the next three years. For me, this is the biggest problem France is facing now." He added that the same situation could also apply to other policy areas, and it would be difficult for any party's key plans to win parliamentary support, leading to "political paralysis."
Analysts are also concerned about the impact of this event on the euro. ThemistoklisFiotakis, Global Head of FX and Emerging Markets Macro Strategy at Barclays Bank, told Yicai reporters that compared to the 2017 French election, France's current political predicament has more similarities with Italy's situation over the past decade. For example, the French president has more discretion in foreign affairs and relations with the EU, and fiscal policy has become the main focus of the government, which could lead to conflicts with EU institutions.
"If Italy's precedent is the correct reference template for France, then the impact of this French national election on the euro may be greater than during the 2017 election," he analyzed, fundamentally, if the National Alliance wins the election, it could affect the market through four main channels: eroding EU institutions from within; causing tensions between France and the EU and EU member states; affecting other elections, such as the 2025 German election; and exacerbating geopolitical risks and tensions related to the Russia-Ukraine situation. Fiotakis added that due to the existing economic divergence between the US and Europe, coupled with France's new political risks, the euro is expected to fluctuate between 1.05 and 1.06 against the US dollar over the next 12 months, further trending downward compared to the recently established 1.05-11.11 range. At the time of Yicai reporters' deadline this afternoon, the euro was trading at 1.0764 against the US dollar.
The "most alarming" forecast comes from the stock market. A team of analysts led by Beata Manthey, Global Head of Equity Strategy at Citigroup, said in a research report last Thursday that the market is currently "too optimistic" about a benign election outcome, but the possibility of a stalemate or extreme situation is higher, and the latter two could lead to a 5% to 20% decline in French stock market valuations. "We also found that the French stock market tends to be more volatile than other developed economies' stock markets before and after elections, so we also expect increased volatility in the French stock market," the team of analysts wrote.
Following that, Manthey warned of the spillover effects of the French election on the entire European stock market in a media interview last Friday. She said that investors are already pricing in the election, but "our models show that the market's pricing is mainly based on benign outcomes and stalemate situations, and the pricing for stalemate situations is not yet complete. More importantly, the market has not yet priced in the situation where the far-right or far-left gains an absolute majority." In fact, "the election outcome is still very uncertain, we have just voted in the first round, and we will know more on June 30."She added that European stocks have been consistently popular with investors this year, with many global investors shifting from US stocks to European stocks, continuously establishing or extending long positions in European stocks, especially in European bank stocks. However, the problem lies in the fact that "Citi's model shows that the current valuation of European stocks is fundamentally based, without taking into account the increased political risks. Based on this, against the backdrop of increased political risks, we have recently downgraded the rating of European stocks and upgraded the rating of US stocks. This is because, in the developed market stock markets, European stocks have always been the most susceptible to political changes and risks. In short, if the French election results are very unfriendly to the market, and the correlation of the European market is strong, European stocks will also be affected by the spillover effect of a significant sell-off in the French stock market," said Mansur.