The second round of parliamentary ‘run-off’ in France this Sunday has become a major focus for financial markets. The outcome of this election is highly unpredictable, with the first round of voting last week resulting in a potential hung parliament. This led to a relief rally in French assets on Monday.
Investors are hoping for a hung parliament because both the far-right Rassemblement National (RN or National Rally) and the New Popular Front (NPF) – an alliance of the far-left France Unbowed, the Greens, and the Socialists – have expressed intentions to increase taxes and public spending aggressively. However, uncertainty remains as the NPF and French President Emmanuel Macron’s centrist Ensemble (Together) alliance work to prevent a victory for the RN.
Under French electoral rules, a second round “run-off” is held between the two best-placed candidates and 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. As a result, the NPF and Ensemble have strategically withdrawn their candidates in seats where they finished third in the first round, in hopes of gaining support from their respective supporters to keep out the RN. According to Le Monde, the second best-selling newspaper in France, 224 candidates have withdrawn.
However, this tactic may not work as planned. The conservative Les Republicains – the party of former presidents Jacques Chirac and Nicolas Sarkozy – has not advised its supporters on how to vote. This could potentially split the anti-RN vote. Additionally, many liberal and conservative voters may be reluctant to vote for the NPF candidate, led by 72-year-old left-wing firebrand Jean-Luc Melenchon, who is often compared to UK politician Jeremy Corbyn.
Former Prime Minister Edouard Philippe, a member of Macron’s party, has urged Ensemble’s candidates to step down in seats where they finished third in the first round and instead support candidates from the center-right or center-left, but not from RN or France Unbowed.
The remaining contests will now be decided by a two-way duel in 409 races, with 89 three-way contests and two four-way battles. With the RN expected to win between 250 and 300 seats in the National Assembly, markets are watching nervously. Since Macron’s surprise announcement of a parliamentary election on June 10, there has been concern among investors about the possibility of either the RN or the NPF winning a parliamentary majority.
As a result, the CAC-40, the leading French stock index, fell by more than 6.5% between June 10 and last Friday. Some individual stocks, such as Societe Generale and Credit Agricole, have fallen even further, by 10% and 7% respectively. The construction-to-telecoms conglomerate Bouygues and the construction and infrastructure services group Vinci, which owns UK-based civil engineer Taylor Woodrow, have also seen significant declines.
There has also been a sell-off in French government bonds, reflecting concerns about increased borrowing under a high-spending RN or NPF government. The yield on 10-year French government bonds rose from 3.118% on the day before the election was called to 3.373% on Tuesday this week. The spread between French and German 10-year government bond yields also widened to its widest point in 12 years, reaching 85.2 basis points.
This has led some investment analysts to speculate that France could face its own mini-budget moment, similar to what happened in 2012 when bond investors sold off the government’s debt due to concerns about excessive borrowing. The uncertainty has also affected the value of the Euro, which has fallen from $1.09 to $1.067 since the announcement of the snap election, though it has since rebounded to around $1.079.
Despite these concerns, some analysts believe that French assets represent good value, assuming the second round of voting results in a hung parliament or a modest majority for the RN, which is considered a more market-friendly outcome than a victory for the NPF. Strategists at Morgan Stanley have stated that they believe both of the remaining election scenarios would ultimately lead to a recovery in French and wider-European equity indices.
There are still widespread concerns, however, with some European Central Bank governors facing questions about whether the ECB would intervene in the markets, if necessary, to support French government bonds. France is currently under an “excessive deficit procedure” with the European Commission due to its budget deficit of 5% of GDP, far exceeding the 3% limit set by the Maastricht Treaty. This puts France at odds with the Commission in the event of a victory for either the RN or the NPF. Some ECB governors have stated that they believe the central bank should not intervene until France has reached an agreement with the Commission over its deficit.
During a panel discussion
