France’s leftists win shock victory prompting a ‘double-edged sword’ as investors grapple with fear and uncertainty

French markets erased initial losses as investors speculated that the lack of a clear majority in the election means the next government will have to compromise, which will keep the most extreme policies off the table. 

The CAC 40 Index added 0.2% after falling as much as 0.6% in early trading. French bonds were little changed, with the 10-year yield at 3.2%, and the euro steadied. 

“For markets this is a double-edged sword,” RBC analysts including Peter Schaffrik wrote. “The left wing alliance is not seen as business friendly and should command less faith in prudent budget management. However, the lack of a clear majority in the Assembly should blunt any spending plans for the time being and act as a cushion for spread widening.”

While money managers have spent the last week or so fretting over a Le Pen-dominated government, the left’s success is still a concern for investors because it amounts to a fresh dose of uncertainty in the euro-area’s second-largest economy and foreshadows more political wrangling ahead. 

Still, the left alliance lacks an absolute majority — limiting how much it can do — and some strategists suggested a hung parliament would be a positive outcome for investors.

The gap between 10-year French and German yields, a measure of credit risk, sits at around 70 basis points, below levels seen at the height of the market rout last month.

“French politics confounds yet again,” said Geoffrey Yu, senior strategist at Bank of New York Mellon. “Based on the results, risks of expansionary fiscal policy remain, and perhaps on the margins have picked up.”

The New Popular Front — which includes the Socialists and far-left France Unbowed — won 178 seats in the National Assembly, according to data compiled by the Interior Ministry. Marine Le Pen’s National Rally, which pollsters last week had seen winning the election, came third with 143, while President Emmanuel Macron’s centrist alliance notched up 156.

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 National Rally would fall short of an outright majority. France’s CAC 40 Index last week erased about half of the losses it endured in the aftermath of Macron’s announcement. 

The outcome is very different: Macron’s centrist party — favored by investors — came in second place, despite a poor showing in the first round of voting. That could leave the president in a position to cobble together a centrist coalition.

What Our Strategists Are Saying…

“Already the French far-left leader is saying he will implement his entire program and that he is unwilling to to enter any deals with Macron. That tone of defiance will hardly sit well with French bond investors.”

— Ven Ram, cross-asset strategist

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. 

The Institut Montaigne estimates that the New Popular Front’s campaign pledges would require nearly €179 billion ($194 billion) in extra funds per year.

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 predicts that — without further measures — debt would 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 fiscal position,” he said. “The European Commission and rating agencies are expecting 20 to 30 billions of cuts but the government will actually have to deal with a party which want to increase spending by 120 billion.”

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