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France Keeps Markets on Edge With Le Pen Fighting Left for Power

(Bloomberg) — President Emmanuel Macron’s snap legislative election has opened the door to a world of uncertainty for investors confronting potentially seismic shifts in French economic policy.

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Whether the outcome brings Marine Le Pen’s far-right party or a leftist alliance closer to power, the contest to control the National Assembly is one of the most scrutinized in decades.

Investors concerned that any winner might swell France’s borrowings are now demanding the highest risk premium on its bonds since 2012, and asking if a sequel to Europe’s last sovereign debt crisis is imminent. Adding to the uncertainty is an electoral system featuring two rounds in 577 districts.

What Bloomberg Economics Says:

“Markets have already demonstrated sensitivity to the political situation in France. Its high debt burden makes France vulnerable to shifts in investor sentiment and there is a clear danger that spreads could widen further if the election prompts a big change in policy direction.”

—Eleonora Mavroedi and Jamie Rush. For their FRANCE INSIGHT, click here

Here are four scenarios that could unfold in the coming weeks — with a look at the policies they could entail, and the consequences for financial markets.

Base Case: Shaky Gridlock

The most likely result based on current polling is one where Le Pen’s National Rally and allies become the largest group in parliament, but fall short of an absolute majority. Under this scenario, her party leader, Jordan Bardella, keeps to his word and refuses to be prime minister of a minority government.

This inflicts gridlock on the lower house, probably requiring Macron to pick a caretaker premier leading an administration constantly vulnerable to collapse in a no-confidence vote, especially over budgets.

Fiscal policy ends up slightly more expansive as lawmakers resist spending cuts as large as those planned by the outgoing government, but European Union pressure still encourages compromise to do the bare minimum.

This outcome ends Macron’s economic reform agenda. The short-term implications for the economy might be limited, but without further pro-business measures or tweaks to labor laws and professional training, France’s long-term growth potential is unlikely to improve.

“We see a significant risk of political gridlock and uncertainty, which could result in maintaining market volatility,” said Theophile Legrand, a strategist at Natixis.

  • Bonds: Investors continue to demand a more elevated premium to hold French bonds, cementing a new hierarchy in Europe where its debt is perceived to be as risky as those of economies including Portugal.

  • Strategists see the spread between France and Germany’s 10-year yields tightening slightly from about 80 basis points to around 70 basis points, but say it’s unlikely to return to the 50 basis points seen before Macron called the snap vote. That higher price of borrowing could cost the French government at least an additional annual €4 billion ($4.3 billion) after five years, according to Finance Ministry estimates.

  • Equities: Stocks with sensitivity to higher yields are likely to suffer, including the French banks, Vinci SA and Eiffage SA. Other domestic stocks less sensitive to sovereign risk like Carrefour SA could see a relief rally.

Le Pen Outperforms: Awkward Partnership

If the National Rally and allies win big enough to form a government, France faces a so-called “cohabitation” where the president runs defense and foreign policy, and domestic and economic affairs are controlled by the far right. That’s a strained outcome because Macron and Le Pen are bitter enemies.

For all the tensions however, the economic and fiscal policy implications could be more benign than suggested by the initial reaction of investors to Macron’s snap vote — potentially echoing Italy’s situation under its populist premier, Giorgia Meloni.

The National Rally has pared back some of its most costly pledges, and must avoid a financial crisis if it wants to build credibility for Le Pen’s likely presidential run in 2027. That means cooperating with the EU on reining in deficits — no mean feat for a group that has often slated Brussels, and once advocated leaving the euro.

Even in this scenario, Bardella needs to deliver some costly policies like cutting sales taxes on energy — estimated to cost €12 billion — to please the working class base Le Pen has built in recent years. The party claims unspecified savings from tackling tax evasion and cutting spending on immigrants will finance that.

“The tone the government takes would matter” for the bond market, Barclays strategists led by Rohan Khanna wrote in a report. “If they take a pragmatic approach to their plans with an eye on the 2027 presidential election, market reaction could be less adverse.”

  • Bonds: Barclays estimates the yield premium relative to Germany will stay elevated at around 80 basis points. But with more fiscal expansion, it could soar to above 100 basis points — a level last seen in the depths of the euro-area debt crisis.

  • Equities: Once again this outcome depends on how far the party pushes France’s tight fiscal headroom. If the government emulates that of Meloni, stocks could benefit. But should France’s credit swaps deteriorate, sectors most at risk would be banks, construction, utilities and defense, while domestic equities likely underperform international peers.

The Left Outperforms: Clash With Brussels

While attention has been focused on the far right, the left-wing New Popular Front that spans market-friendly social-democrats to communists has been building momentum in opinion polls.

It’s not clear how that group could end up with a significant influence on policy, but the unpredictable two-round system means it can’t be ruled out. If the NPF gets a role in policymaking, and its most radical members retain the upper hand, that’s likely to be the most negative outcome for markets.

Under this scenario, the alliance pushes to reverse seven years of pro-business reform, while adding vast new spending plans and large increases in the minimum wage. A clash with Brussels is inevitable, and potentially calamitous.

“Their program represents a very large fiscal expansion and a confrontational approach to the EU,” said Jason Davis, global rates portfolio manager at J.P. Morgan Asset Management. “The market will fear both the fiscal consequence in France and the broader consequences for European cohesion.”

  • Bonds: This is the worst-case scenario and one that would likely send the spread soaring above 100 basis points, according to Davis.

  • Equities: This is a high-risk outcome currently underpriced by stock markets, which are focused on potential National Rally win. A previous far-left government in the 1980s triggered a capital flight. Some strategists see a plunge of 20% for the CAC 40 index in the immediate aftermath of this.

Macron Prevails

In a scenario polls suggest to be extremely unlikely, Macron’s party and allies minimize their losses and remain the biggest group, allowing them to maintain the limited control they’ve had on the legislature since losing an absolute majority in the 2022 elections.

In theory, the president can appoint a government to resume his reform agenda and pursue fiscal consolidation based on deeper spending cuts.

Even if this happens, Macron is still likely have to show he has heard the demand of most parties to do more for households pocketbooks and less for business, curbing his room for maneuver on the public finances. The threat of a resurgence of the far right or left can’t be permanently eradicated either.

“Longer term, French spreads should settle at levels that are structurally wider than prior to the snap election,” said J.P. Morgan Asset Management’s Davis. “You are better placed buying other credits with better credit stories, such as Spain, for a longer-term trade.”

  • Bonds: Some strategists say this outcome could allow bond yield spreads to return to the 50 basis point level seen earlier this month.

  • Equities: Stocks would likely rally fast and recover to levels seen before the parliament dissolution, with domestic stocks in the driving seat.

Get Bloomberg’s coverage of the French election in your inbox by signing up to our newsletter, The Paris Edition. Terminal users can sign up here. If you’re reading this online, this is the link you need.

–With assistance from Zoe Schneeweiss.

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