France elections: Far-right knocking on gates of power after first round

Executive summary:

The far-right party National Rally (RN) emerged as the strongest party in France’s first round of elections for the National Assembly. They have a small chance of winning an outright majority of seats in the second round of voting.
Leaders of the centrist parties are calling for a withdrawal of candidates and tactical voting to prevent an RN government. A hung parliament is the most likely outcome.
Investors should still expect heightened market volatility as the second round of voting is held on July 7.

After his party’s dismal showing at the recent European elections, French president Emanuel Macron surprisingly called an early poll for the National Assembly, the lower house of Parliament. In Sunday’s first round of voting, candidates competed for the outright majority in one of 577 constituencies. The far-right party of former presidential candidate Marine Le Pen, National Rally (RN), emerged as the strongest political force in the first round, gaining 33.5% of the votes. The newly formed left-wing alliance, Nouveau Front Populaire (NFP), came in second with 28.1% and President Macron’s coalition a distant third with 20.7%.

Second round outcome on knife’s edge

Second round runoff votes will be held on July 7 in constituencies where no candidate was able to secure 50% of the votes. In the run-off, the top candidates who got at least 12.5% of the voters' support in the first round compete again. Usually, this leads to a head-to-head contest, but sometimes a multi-candidate race can ensue.

Based on Sunday’s first round results, the RN is projected to gain 230-280 seats, putting them in reach of an absolute majority of 289 seats. However, such projections should be treated with caution, as they are notoriously unreliable and the outcome of the second round depends much on the specific situation in each constituency.

Gabriel Attal, the prime minister from President Macron’s party, warned that the far-right RN is at the gate of power. He called for moderate parties to work together, i.e., third-placed candidates in run-offs to withdraw to prevent the RN from governing. Other politicians representing an informal coalition against the far-right made similar statements.

What would an RN government mean…?

In addition to its euro-sceptic stance, the trepidation of financial markets towards an RN government also stems from the projected €100bn cost of policies that were laid out for the 2022 presidential election[1]. These included lowering the retirement age, eliminating income tax for citizens under 30, and lowering the value-added tax (VAT) on energy, petrol and essential household goods. More recently, Jordan Bardella, the presumptive prime minister if the RN forms the government, has tried to paint himself as fiscally responsible. He promised to put some of the measures on hold and reign in the budget deficit, but markets don’t quite buy this transformation.

…for European bonds and the euro?

A good indicator for political risk emanating from the election is the spread of French government over German government bonds (bunds) with 10 years maturity. This spread had risen from around 0.5% before the election was called to more than 0.8% on the eve of the polls. The EUR/USD exchange rate is a similar barometer of perceived political risk and usually correlates inversely with the spread (see chart below).

When markets reopened on Monday after the first round, the 10Y France-Bund spread tightened to below 80 basis points and the euro strengthened by 0.4%, suggesting relief at the outcome. Based on the past relationship between the bond spread and the EUR/USD exchange rate, we think that the EUR has more downside in a negative scenario while bond markets have more fully priced an RN majority.

…for French and European equities

French stocks sold off strongly in recent weeks on the prospect of a right-wing euro-sceptic government. On our composite contrarian sentiment indicator for French vs. European equities, an oversold signal was triggered, suggesting that a countermove was becoming more likely (see chart below).

French equities look oversold

Source: Russell Investments, as of 26 June 2024. Negative values in this chart indicate sentiment is oversold, and positive values indicate sentiment is overbought.

On Monday, the CAC40 index rebounded by more than 2% as the first-round outcome seemed to curtail the tail risk of an outright RN majority. Euro area equities excluding France have been much less affected by the political turmoil, but are also off their 2024 highs.

The bottom line

Nothing has been decided in the first round of legislative elections in France. A hung parliament still seems the most likely outcome, but even a small likelihood of an outright majority for the euro-sceptic RN remains uncomfortable for financial markets.

Volatility will stay high until after the second round of voting on 7 July. French stocks and bonds appear to have priced the negative scenario of an RN government, but the euro could have some downside if the RN wins a parliamentary majority.

Almost irrespective of the outcome, Macron’s gamble of calling an early election may misfire by showing that voters have rejected his policies and making France less governable.

¹ Source: Institute Montaigne.