Forget the UK general election.
The poll that financial markets will be watching most closely over the next few days is the second round parliamentary ‘run-off’ in France this Sunday.
The French poll is unpredictable, to say the least.
The first round of voting last week raised the prospect of a hung parliament and prompted a relief rally in French assets on Monday this week.
Markets would prefer a hung parliament because Marine Le Pen’s 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 – both want to raise taxes and public spending aggressively.
But uncertainty remains in the air as the NPF and French President Emmanuel Macron‘s centrist Ensemble (Together) alliance scramble to prevent a triumph for RN.
What next in French voting?
Under French electoral rules, where no candidate won outright in the first round of voting, a second round “run-off” is held between the two best-placed candidates and any other candidates who garnered more than 12.5% of the vote during the first round. Whoever gets the most votes in the second round wins.
Accordingly, both the NPF and Ensemble have been standing down the majority of candidates in seats where they finished third last time – in the hope their supporters will vote tactically to keep out the RN.
Le Monde, the second best-selling newspaper in France, reported yesterday that 224 candidates have withdrawn.
Tactical questions
The tactic may not work, however, not least because the conservative Les Republicains – the party of former presidents Jacques Chirac and Nicolas Sarkozy and which won 10.2% of the votes last Sunday – has given no such guidance to its supporters and could thus split the anti-RN vote.
Moreover, a lot of liberal and conservative voters will be reluctant to vote for the NPF candidate when they come from France Unbowed, led by the 72-year-old left-wing firebrand Jean-Luc Melenchon, who is often characterised as a French version of Jeremy Corbyn and who put together the alliance.
Edouard Philippe, Mr Macron’s former prime minister, has urged Ensemble’s candidates to step down where they were in third place during the first round and get behind centre-right or centre-left candidates – but not candidates from RN or France Unbowed.
A nervous watch
Le Monde estimates that, of the remaining contests, some 409 will now be decided by a two-way duel. There are 89 three-way contests and two four-way battles.
With the RN expected by pollsters to get anything between 250 and 300 seats in the National Assembly – 289 is required for a majority and it came first in 296 seats in the first round – that has left markets watching nervously.
Ever since Mr Macron stunned Europe on 10 June by calling a parliamentary election, after Ensemble suffered a spanking in the European parliamentary election, investors have been rattled by the prospect of either RN or the NPF winning a parliamentary majority.
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Market reactions so far
The CAC-40, the leading French stock index, fell by more than 6.5% between 10 June and last Friday – the final day before the first round of voting.
Some individual stocks have fallen by more, though, with the banks Societe Generale and Credit Agricole down 10% and 7% respectively since Mr Macron called the election. The construction-to-telecoms conglomerate Bouygues has also fallen by 10% and Vinci, the construction and infrastructure services group which owns the UK civil engineer Taylor Woodrow, is down by more than 7.5%.
There has also been a sell-off in French government bonds – reflecting concerns that a high-spending RN or NPF government would increase borrowing.
The yield (bond yields rise as the price falls) on 10-year French government bonds jumped from 3.118% on the day before Mr Macron called the election to as much as 3.373% on Tuesday this week.
And the premium that investors demand for holding 10-year French government bonds over their German equivalent surged from 47.61 basis points (0.4761%) before Mr Macron called the election to as much as 85.2 basis points (0.852%) last Friday – a sharp and pronounced move highlighting the anxiety of investors and taking the spread to its widest in 12 years.
A French-style mini-budget moment?
It has led some investment analysts to speculate that France could suffer its own mini-budget moment – where bond investors sell the government’s debt for fear of extra borrowing surging out of control.
The uncertainty has even spilled over to the Euro, which has fallen from $1.09 just before the European elections to as low as $1.067 in the days after Mr Macron called the snap poll, although it has since rallied to around $1.079.
Some analysts now argue French assets represent good value, assuming the second round of voting produces a hung parliament or a modest majority for the RN, which is regarded as a more market-friendly outcome than a victory for the NPF.
Marina Zavolock and Regiane Yamanari, strategists at Morgan Stanley, told clients today: “We believe the two key remaining French election scenarios – no majority and RN absolute majority – would both ultimately be followed by a recovery in French and wider-European equities indices.”
Already existing concerns
But there are still widespread concerns – and so serious are they that the European Central Bank has even faced questions this week at its annual Central Banking Forum in Sintra, Portugal, over whether it would be prepared to intervene in the markets, if necessary, to prop up French government bonds.
France is already under a so-called “excessive deficit procedure” with the European Commission for running a budget deficit of 5% of GDP – well ahead of the 3% limit led out by the Maastricht Treaty. That was already putting it on a potential collision course with Brussels in the event of a victory for either the RN or the NPF.
Some leeway ‘because it’s France’
France has traditionally enjoyed a certain amount of leeway from Brussels over running excessive deficits because of its importance to the eurozone – where it is the second-largest economy behind Germany.
That attitude was famously summed up by Jean-Claude Juncker, a former commission president, when he was asked in 2016 why France was not forced to play by the same rules as, say, Greece or Portugal: “Because it’s France.”
But Reuters reported today that some of the ECB’s governors are expected to insist that the central bank should not intervene until Paris has thrashed out some kind of agreement with the Commission over its deficit.
However, during a panel discussion, Christine Lagarde, the ECB president, indicated the ECB could intervene and especially if a sell-off in French government debts spread contagion to other Eurozone debt – just as her predecessor, Mario Draghi, did in 2012.
Ms Lagarde said: “The European Central Bank has to do what it has to do. Our mandate is price stability. Price stability is obviously relying on financial stability, and we are attentive to that.”
So markets have been put on notice.
The bigger picture, though, is that bond investors will continue to have concerns about the French deficit whatever the outcome on Sunday.