Why the French election result matters more to financial markets than the UK vote | Business News

Forget the British general election.

The poll that financial markets will be watching most closely in the coming days is the second round of the French parliamentary elections this Sunday.

French opinion polls can be said to be unpredictable, to say the least.

Last week's first-round vote raised the possibility of a deadlock in parliament, sparking a relief rally in French assets on Monday.

Markets would prefer a deadlock in parliament, as both Marine Le Pen's far-right National Rally (RN, or National Rally) and the far-left New Popular Front (NPF), a coalition of France's Gulzón, Greens and Socialists, are aggressively pushing for tax and public spending increases.

But uncertainty still hangs in the air as the NPF and French President Emmanuel Macron's centrist Ensemble coalition try to block the RN's victory.

What's next for the French vote?

Under French electoral rules, if no candidate wins the first round, a second round, called a “runoff”, is held between the two highest-ranking candidates, plus any other candidates who received more than 12.5% ​​of the vote in the first round. The candidate with the most votes in the second round wins.

So both NPF and Ensemble have withdrawn most of their candidates from the seats where they came third in the last election, in the hope that their supporters will strategically block RN.

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14:41 French elections: Who is the National Rally?

Le Monde, France's second-biggest newspaper, reported yesterday that 224 candidates had withdrawn.

Tactical question

But this strategy may not work because the conservative party Les Puerto Ricans (which won 10.2% of the vote on Sunday, led by former presidents Jacques Chirac and Nicolas Sarkozy) has not given its supporters such guidance, which could split the anti-RN vote.

Moreover, many liberal and conservative voters will be reluctant to vote for the 72-year-old left-wing firebrand Jean-Luc Mélenchon, who is often described as France’s version of Jeremy Corbyn and who has formed a coalition.

Macron's former prime minister, Edouard Philippe, has urged the Ensemble candidates to step aside from their third-place finish in the first round and back a centre-right or centre-left candidate, but not the RN or France Unbowed.

A tense watch

Le Monde estimates that around 409 of the remaining contests will now be decided by two-way duels, 89 by three-way and two by four-way.

Pollsters predict that the RN will win 250-300 seats in the National Assembly. It needs 289 seats to win a majority, and the RN came in first place with 296 seats in the first round. This has the market watching with concern.

After Ensemble suffered a major blow in the European Parliament elections, and after President Macron surprised Europe by announcing that parliamentary elections would be held on June 10, investors were nervous about the possibility of the RN or NPF winning a majority in parliament.

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Market reaction so far

France's main stock index, the CAC-40, fell more than 6.5% between June 10 and last Friday (the last day before the first round of voting).

But some individual stocks fell even further, with banks Societe Generale and Credit Agricole down 10% and 7% respectively since Macron called the election. Construction and telecommunications giant Bouygues also fell 10%, while Vinci, the construction and infrastructure services group that owns British civil engineer Taylor Woodrow, fell more than 7.5%.

There was also a sale of French government bonds, reflecting concerns that a spending-heavy RN or NPF government would increase borrowing.

The yield on French 10-year government bonds (bond yields rise as prices fall) jumped from 3.118% the day before President Macron announced he would call elections to a whopping 3.373% this Tuesday.

And the premium that investors demand to hold 10-year French government bonds over German bunds soared from 47.61 basis points, or 0.4761%, before Macron called elections, to a whopping 85.2 basis points, or 0.852%, on Friday, a sharp and striking move that betrays investor anxiety and the widening of the spread to its widest level in 12 years.

French style mini budget film?

Some investment analysts have even speculated that France could suffer a mini-budget crisis, where bond investors sell government bonds for fear of uncontrolled borrowing.

The uncertainty has also affected the euro, which was at $1.09 just before the European Parliament vote but fell to $1.067 in the days after President Macron called for an early vote, but has since recovered to around $1.079.

Some analysts argue that French assets represent good value as they expect the second round of voting to either result in a deadlock in parliament or a narrow majority for the RN, which would be seen as a more market-friendly outcome than an NPF victory.

Morgan Stanley strategists Marina Zavolock and Regiane Yamanari told clients today: “We believe that both of the remaining major election scenarios in France – no majority and an absolute majority for the RN – would ultimately lead to a recovery in equity indices for France and Europe as a whole.”

Pre-existing concerns

But concerns remain widespread, so serious that the European Central Bank was asked at its annual central bank forum in Sintra, Portugal, this week whether it would be willing to intervene in the market if necessary to support French government bonds.

France is already in the so-called “excessive deficit procedure” with the European Commission to run a budget deficit of 5% of GDP, well above the 3% limit set by the Maastricht Treaty, meaning that a victory by the RN or NPF could already put it on the brink of a clash with Brussels.

Because it's France, there's a bit of leeway.

As the euro zone's second-largest economy after Germany, France has traditionally enjoyed a degree of leniency from Brussels when it comes to running excessive budget deficits.

That attitude was well expressed in the response of former European Commission President Jean-Claude Juncker when asked in 2016 why France was not forced to play by the same rules as Greece or Portugal. “Because we are France,” he said.

But Reuters reported today that some ECB presidents are expected to argue that the central bank should not intervene until Paris reaches some kind of agreement with the fiscal committee on deficits.

But in a panel discussion, ECB President Christine Lagarde said the ECB could intervene, especially if the sale of French government bonds spreads to other euro zone bonds, as her predecessor Mario Draghi did in 2012.

“The European Central Bank has to do what it has to do. Our job is price stability. Price stability obviously depends on financial stability, and we are paying attention to that,” Lagarde said.

So a warning was sent to the market.

But the bigger picture is that bond investors will remain concerned about the French deficit regardless of Sunday's outcome.

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