European Markets Rise on Bets Le Pen to Miss Absolute Majority

The euro strengthened and European stock futures gained as traders digested signs that Marine Le Pen’s far-right party was poised to win the first round of France’s legislative election with a smaller margin than some polls had indicated, Bloomberg reported.

The common currency climbed 0.4% to $1.076 at 7:39 a.m. in Paris on Monday, touching its highest intraday since June 18. Contracts on the Euro Stoxx 50 Index — where French equities have about a 40% weighting — rose 1.9%. French bond futures edged higher, even as German and other global peers sold off.

Initial projections showed Le Pen’s far-right party in front of President Emmanuel Macron’s centrist alliance and the left-wing New Popular Front — but with potentially less of the vote than it needs to secure an absolute majority after a second round of polling July 7.

Investors have been concerned that a strong showing for Le Pen’s National Rally would increase the odds of expansive fiscal policy, bringing the nation’s bloated fiscal accounts sharply into focus and further muddying the outlook for the common currency.

The focus now turns to whether her party can garner enough support July 7 to get an absolute majority in the National Assembly, which would allow it to pass legislation more easily. President Emmanuel Macron and her other opponents are already strategizing to keep the far-right party out of power, with any signs of progress likely to bolster the case for a relief rally.

“We now have a week of horse-trading ahead of us,” said Joachim Klement, head of strategy, accounting and sustainability at Liberum Capital, who expects the euro to strengthen through the week as alliances are formed to reduce the gains of Le Pen’s party.

If the leftist alliance “is aimed at blocking Le Pen’s grouping from getting a majority in the crucial second round, it has wide-ranging implications for the France-German spread and, indeed, the euro. If the upshot is that we will get a more centrist government, it would be positive for the currency and herald a narrower spread.”

Five polling companies’ analysis late Sunday projected that the National Rally would get as much as 34% of the vote. Bloomberg’s final poll of polls on Friday put it at 36.2%.

The left-wing New Popular Front coalition was set to get about 29% and Macron’s centrist alliance between 21% and 22%, projections on Sunday showed.

“Both camps’ fiscal policies are disruptive for the French economy and the prospects for the French debt,” said Vincent Juvyns, global market strategist at JPMorgan Asset Management, referring to the National Rally party and the New Popular Front coalition. “For me, it’s still wait-and-see.”

According to Kathleen Brooks, research director at XTB, if alliances forming to block Le Pen from absolute power start to look credible, French markets would likely recover.

“A hung parliament could make it hard to get anything done in France in the current parliament, which is exactly what the markets would like,” she said.

Still, strategists warn there is likely volatility ahead, as the electoral calculus gets complicated in the runoff when parties can strategically withhold candidates in certain constituencies to give a boost to a centrist hopeful.

Macron’s decision to call a snap vote in early June had sent markets into a tailspin.

His party — which supports large spending cuts to get France’s budget deficit under control — suffered a crushing defeat in European parliamentary elections. National Rally, meanwhile, has touted some costly budget measures including lowering the sales tax on energy and fuel.

Over the past two weeks, the extra yield investors demand to hold 10-year French bonds over safer German debt rocketed to more than 80 basis points, levels last seen during the euro area’s sovereign debt crisis. The euro fell to its lowest since early May.

Fiscal Pressures

While the 10-year yield spread may find some relief as trading starts on Monday, it’s hard to see a “material and sustainable snapback,” said Peter Goves, head of developed market debt sovereign research at MFS Investment Management.

“Uncertainties are high, French fundamentals haven’t changed and the final outcome is still unknown and unknowable with the large number of three-way contests complicating matters,” he said.

At a projected 5.3% of output this year, France’s budget deficit already far exceeds the 3% of economic output allowed under European Union rules. The International Monetary Fund predicts 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.