Surprise victory of leftists in France, a “double-edged sword” for investors grappling with fear and uncertainty

The CAC 40 index rose 0.2% after falling 0.6% in early trading. French bonds were little changed, with a 10-year yield at 3.2%, and the euro stabilized.

“For markets, this is a double-edged sword,” wrote RBC analysts, including Peter Schaffrik. “The left-wing alliance is not seen as business-friendly and should create less confidence in prudent fiscal management. However, the lack of a clear majority in the assembly should put the brakes on any spending plans for now and act as a buffer against a widening of rate spreads.”

While fund managers have spent the past week fretting about a Le Pen-dominated government, the left’s success remains a source of concern for investors as it represents a fresh dose of uncertainty in the euro zone’s second-largest economy and suggests more political wrangling to come.

However, the left-wing alliance does not have an absolute majority – which limits its scope for action – and some strategists have suggested that a parliament without an absolute majority would be a positive outcome for investors.

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

“French policy is once again confusing,” said Geoffrey Yu, senior strategist at Bank of New York Mellon. “Given the results, the risks of expansionary fiscal policy remain and may have increased to some extent.”

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

French markets plunged in June, wiping out billions of euros from stocks and bonds as Macron’s snap election raised concerns about a far-right takeover. But over the past week, traders have pared some of those losses as opinion polls have indicated the National Rally party will fall short of an outright majority. Last week, France’s CAC 40 index erased about half of the losses it suffered following Macron’s announcement.

The result is quite different: Macron’s centrist party, popular with investors, comes in second, despite a mediocre first-round showing. The president may thus be able to put together a centrist coalition.

What our strategists say…

“The leader of the French far left is already saying that he will implement his entire program and that he is not willing to make any deal with Macron. This defiant tone will not please French bond investors.”

— Ven Ram, Multi-Asset Strategist

Investors had identified an absolute majority for the left as the scenario that worried them most in the run-up to the first round of voting. But that possibility was ruled out after Marine Le Pen’s National Rally won convincingly in the first round. Among its promises, the left-wing coalition wants to reverse seven years of pro-business reforms and raise the minimum wage.

The Montaigne Institute estimates that the New Popular Front’s campaign promises would require nearly 179 billion euros ($194 billion) in additional funds per year.

France is already struggling with a budget deficit of 5.5%, which is well above the 3% of GDP allowed by European Union rules. The International Monetary Fund projects that without new measures, the debt would reach 112% of GDP in 2024, and would increase by about 1.5 percentage points per year over the medium term.

Ratings agency S&P Global downgraded France’s rating in late May, highlighting the French government’s missed targets in its plans to limit the budget deficit after huge spending during the Covid pandemic and the energy crisis.

Vincent Juvyns, global markets strategist at JP Morgan Asset Management, said tensions were likely as Macron’s reforms were now being called into question, which could hurt the value of French bonds relative to their peers.

“Markets may demand a higher spread until the new government clarifies its budgetary position,” he said. “The European Commission and rating agencies expect budget cuts of €20-30 billion, but the government will actually have to face a party that wants to increase spending by €120 billion.”