French election: It’s all over for Marine Le Pen, but the Left weighs on the euro

The deciding vote in the French Parliamentary elections closed this evening, and the exit poll suggests a shock result. The winning party is the left alliance, the popular front, which was pulled together to try and keep Le Pen’s far right National Rally party out of power. Their plan has worked, and there has been an extraordinary turnout for the left-wing alliance. They are set to win between 170-215 seats, Macron’s centrist party is expected to come in second place with 150-182 seats, while the National Rally are trailing in third place and only expected to win 110-158 seats.

EUR falls after French election results

The immediate market impact can be felt in the euro. EUR/USD is lower at the start of the week, dropping some 30 pips after this result, which suggests that it could be a tough start for French stocks and bonds on Monday. While the prospect of a far right government in France has been put to bed for now, the FX markets is not giving a warm welcome to the left-wing alliance. For now, $1.0800 is looking like decent support, as we wait to see who will become the next Prime Minister of France and what this means for tax and spending plans.

French political chaos ensues

You will notice that no party has secured to 289 seats required to form a government, which means the French parliament will be run by a coalition. The question now is, who will join the popular front and form a government? The left-wing alliance is made up of the Socialist party and France Unbowed, a far-left party. Interestingly, France Unbowed made the largest gains in the left-wing alliance, winning between 83-90 seats, according to exit polls. The leader of France Unbowed, Jean Luc Melenchon, has said that he will implement his ‘entire programme’ and he has refused any negotiation with President Macron’s centrist government. Melenchon’s main policy priorities include rolling back Macron’s pension reforms, freezing the price of some consumer staples and raising the minimum wage. These are policies that could send shivers down the spine of investors. France has a budget deficit of 5.5%, and concerns about its fiscal health have pushed the French – German 10-year bond yield spread to its highest level since the sovereign debt crisis. If the far left do form a government, their policies, if enacted, would certainly aggravate France’s fiscal position, and put the country on course to clash with Brussels over a breach of fiscal rules. This is why the euro is weakening at the start of the week.

However, losses for the euro and other French asset classes could be capped, since the left-wing alliance do not have an overall majority. If they want to get into power, then the most practical way to do this is to form a coalition with Macron’s party. Right now, that is ruled out, however, pragmaticism could still come into play as negotiations continue. Overall, it looks like it will take some time before a government in France will be formed.

A pyrrhic victory for Macron

At this stage, it seems that Macron’s calculated election announcement, along with the efforts to keep the far right out of office have paid off, however, it could be a pyrrhic victory if the top two placed parties cannot form a functioning government. The relief rally in French asset prices last week that saw the French Cac 40 rally nearly 4% on a currency adjusted basis, but this may be in jeopardy as we start a new week. The French – German 10-year bond yield spread fell to 65 basis points from 80 basis points ahead of the first round of voting. This spread had been 44 basis points before the French election was called, we do not see it returning to these norms in the aftermath of tonight’s result.

Fiscal concerns are front and centre

The longer-term impact of this election on financial markets will depend on who becomes prime minister. The worst outcome for French asset prices would be a far left or left-leaning PM for France who wants to increase tax and spending. The markets do not like European leaders who threaten the fiscal stability of a country, hence the reaction to Liz Truss’s budget in the UK in 2022.

How the markets could react

However, there are other options that could be less negative for French asset prices. Firstly, a moderate left-wing Socialist Prime Minister, who would stand a chance of working cooperatively with President Macron. The leader of the Socialist Party has said that he will not continue with Macron’s policies, however, he sounded more conciliatory than Melenchon. Secondly, this election result could usher in a period of political instability as the various parties try to form a coalition and President Macron waits to pick a Prime Minister. This could take some time, and if there is a hung parliament, then it may require a fresh vote in a year’s time. Overall, if France can’t form a government, then this may be the best outcome for French asset prices.

The far right remains a threat

At the back of investors’ minds could be the continuing threat of Marine Le Pen’s National Rally party. The far right might be down, but they are not out. They will continue to be a big force in French politics as we lead up to the French presidential election in 2027. If they boost their popularity in the coming months, then we would expect a political risk premium to continue to be attached to French asset prices for the long term, which could limit any recovery for French stocks and bonds.