Forget the British general election.
The poll that financial markets will be watching most closely in the coming days is the second round of parliamentary elections in France this Sunday.
The French poll is unpredictable, to say the least.
The first round of voting The prospect of a stalemate in parliament was already raised last week, leading to a relief meeting in French institutions on Monday this week.
Markets would prefer a parliament with an uncoordinated majority, as Marine Le Pen’s far-right Rassemblement National (RN) and the Nouveau Popular Front (NPF) – an alliance of the far-left France Unbowed, the Greens and the Socialists – both want to aggressively increase taxes and government spending.
But uncertainty remains in the air as the NPF and the French president Emmanuel MacronThe centrist alliance Ensemble (Together) is trying to prevent a victory for the RN.
What’s next in the French vote?
Under French electoral rules, where no candidate wins outright in the first round of voting, a second round “run-off” is held between the two best-placed candidates and all other candidates who received more than 12.5% of the vote in the first round. The one who receives the most votes in the second round wins.
That is why both the NPF and Ensemble have withdrawn most of their candidates from seats where they finished third last time, hoping that their supporters will vote tactically to keep the RN out.
Le Monde, France’s second-best-selling newspaper, reported yesterday that 224 candidates had withdrawn.
Tactical questions
However, this tactic may not work, not least because the conservative Les Republicains – the party of former presidents Jacques Chirac And Nicolas Sarkozy and who received 10.2% of the vote last Sunday – has given no indication to her supporters about this and could therefore divide the anti-RN vote.
Moreover, many liberal and conservative voters will be reluctant to vote for the NPF candidate if they come from France. Unbowed, led by 72-year-old left-wing fanatic Jean-Luc Melenchon, who is often characterized as a French version of Jeremy Corbyn and who founded the alliance.
Edouard Philippe, Macron’s former prime minister, has called on Ensemble candidates to abandon the third place they took in the first round and to rally behind centre-right or centre-left candidates. They should not target candidates from the RN or France Unbowed.
A nervous watch
Le Monde estimates that of the remaining matches, some 409 are now decided by a two-way duel. There are 89 three-way contests and two four-way battles.
Polls expect the RN to win between 250 and 300 seats in the National Assembly (289 seats are needed for a majority), and in the first round the RN came first with 296 seats). Markets are therefore watching with bated breath.
Since Macron stunned Europe on June 10 by the calling of parliamentary electionsAfter Ensemble suffered a drubbing in the European parliamentary elections, investors are concerned about the prospect of RN or the NPF gaining a parliamentary majority.
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Market reactions so far
The CAC-40, France’s main stock index, fell by more than 6.5% between June 10 and last Friday – the last day before the first round of voting.
Some individual stocks have fallen even more, however, with banks Societe Generale and Credit Agricole down 10% and 7% respectively since Macron called the election. Construction-to-telecoms conglomerate Bouygues has also fallen 10%, and Vinci, the construction and infrastructure services group that owns British civil engineer Taylor Woodrow, has fallen more than 7.5%.
There has also been a sell-off in French government bonds, amid concerns that a high-spending RN or NPF government would increase borrowing.
The yield (bond yields rise as prices fall) on 10-year French government bonds rose from 3.118% the day before Macron called the election to a whopping 3.373% on Tuesday this week.
And the premium investors demand for holding 10-year French government bonds over German government bonds rose from 47.61 basis points (0.4761%) before Macron called the election to a whopping 85.2 basis points (0.852%) on Friday. The sharp and striking move underscores investor concerns and takes the spread to its highest level in 12 years.
A mini budget moment in French style?
This has led some investment analysts to speculate that France could see a mini-fiscal moment of its own, with bond investors sell the government debt for fear that the additional borrowing would get out of hand.
The uncertainty has also spread to the euro, which fell from $1.09 just before the European elections to a low of $1.067 in the days after Macron announced the polls. Since then, however, the euro has rebounded to around $1.079.
Some analysts now argue that French assets represent good value, assuming the second round of voting results in a parliament unable to vote or a modest majority for the RN, which is seen as a more favourable outcome for the market than a victory for the NPF.
Marina Zavolock and Regiane Yamanari, strategists at Morgan Stanley, told their clients today: “We believe that the two main remaining French election scenarios – no majority and an outright majority for the RN – will ultimately lead to a recovery in French and broader European equity indices.”
Pre-existing concerns
Yet there are still many concerns. These concerns are so serious that the European Central Bank was even asked this week at its annual Central Banking Forum in Sintra, Portugal, whether it would be prepared to intervene in the markets, if necessary, to prop up French government bonds.
France is already subject to a so-called “excessive deficit procedure” at the European Commission for having a budget deficit of 5% of GDP – well above the 3% limit set by the Maastricht Treaty. That has already put it on a potential collision course with Brussels in the event of a victory for either the RN or the NPF.
A little leeway ‘because it’s France’
France has traditionally enjoyed a certain degree of latitude Brussels the build-up of excessive deficits because of its importance to the eurozone, where it is the second largest economy after Germany.
That attitude was famously summed up by Jean-Claude Junckerformer Commission President, when asked in 2016 why France was not forced to abide by the same rules as, say, Greece or Portugal: “Because it is France.”
But Reuters reported today that some ECB governors are likely to insist that the central bank should not intervene until Paris reaches some kind of deal with the Commission on the budget deficit.
However, during a panel discussion, ECB President Christine Lagarde indicated that the ECB could intervene, especially if a sell-off in French government debt were to cause a contagion to other eurozone debt – just as her predecessor, Mario Draghi, did in 2012.
Ms Lagarde said: “The European Central Bank must do what it has to do. Our mandate is price stability. Price stability is of course dependent on financial stability, and that is what we are paying attention to.”
So the markets have been warned.
The bigger picture, however, is that bond investors remain concerned about France’s budget deficit, regardless of Sunday’s outcome.