Investment managers discuss the investment impact of the first round of the French parliamentary elections, which saw the highest voter turnout since 1997 at 65.5 per cent, before the second round on 7 July.

The first round of voting in the French parliamentary elections shows that the right-wing Rassemblement National (RN) party is in the lead, whilst President Macron’s moderate Ensemble alliance is coming in third, as the polls predicted.

“The market is reacting positively to what seems to be a less strong lead by the RN party, which reduces the risk of an outright absolute majority post the second round to be held on 7 July,” Zehrid Osmani, head of the global long-term unconstrained team at Martin Currie, part of Franklin Templeton, said in a note.

Given the high number of three-candidate races in the second round, Mark Haefele, UBS Global Wealth Management chief investment officer, believes it is likely that no absolute majority will be achieved in the National Assembly, which could lead to a period of political instability. He pinpoints a hung parliament as one possible outcome, leading to policy deadlock and a government composed of moderate parties.

His view is shared by David Zahn, head of European fixed income at investment manager Franklin Templeton. “Looking ahead to the second round of voting on 7 July, it seems improbable that Marine Le Pen’s Rassemblement National party will achieve a majority, meaning that investors will likely be contending with a hung parliament and continued political unease in France for the foreseeable future,” Zahn said in a note.

Market reaction
Haefele highlighted how the performance of French assets already reflects increased market nervousness in the run-up to the first round of elections: Sovereign bond market yield spreads have widened and French equities have underperformed relative to other European markets.  

“Uncertainty is likely to weigh on equities. The poor showing by President Macron’s Ensemble party in the first round means that French and eurozone equities will likely struggle to recover some of their recent losses,” Haefele said. He expects risks to utilities and infrastructure/toll-road companies from the RN’s proposed policies to persist. Fiscal concerns will also linger until there is greater clarity after round two, preventing a larger rebound in stocks such as financials and defence stocks. He expects European markets to remain volatile given that there is still elevated uncertainty heading into the second round of the election.

Fixed income
Haefele sees better relative value in select corporate bonds from multinational companies. The fundamental trend for French sovereign credit is deteriorating, in his view, with a high and rising debt ratio, elevated fiscal deficits, and an increasing cost of funding. He believes that none of the possible outcomes of the elections would significantly alter this trend in the short term. Considering their manifesto proposals, Haefele thinks investors would likely be concerned about a NFP/RN-led government, and risk premiums for French bonds are likely to remain elevated in the coming months. He sees better relative value in select corporate bonds from multinational companies and government bonds of countries with a less challenged debt outlook.

Zahn also believes that being underweight in French government bonds remains sensible. Zahn expects to see continued volatility, not only over the coming week, but over the coming year, with continued political instability representing the biggest known risk to French markets. He anticipates French government bond spreads to remain wide for the foreseeable future and believes that the current spreads represent a new normal: “While it is conceivable that there could be some tightening in the months ahead, investors will have to adapt to trading on wider spreads in the long term, whatever the outcome of this election.” 

Zahn also highlighted how getting the deficit under control in France will be a major challenge and a necessary priority for the next French administration, but doing so without a parliamentary majority would be especially difficult. “Both the right and left have sizeable spending plans, which are at odds with the goal of bringing down the deficit. It is also conceivable that parliament could be collapsed again in a year’s time in another attempt to achieve a workable majority,” Zahn said.

“The RN has expressed a willingness to respect the EU’s fiscal rules, perhaps seeking to emulate the success of Italy’s Giorgia Meloni, who has generally become more market-friendly since taking office. However, seeking to reduce the deficit and achieving this in practice are two very different things, and investors are right to remain cautious in their optimism,” he added.

Haefele also believes that the euro is likely to come under pressure. As the results stand, the probability that no majority will emerge from the election appears significant. One challenge for investors is to avoid overreacting to the first-round results. In addition, Haefele believes political biases can be counterproductive for investment portfolios and investors should focus on the long term: “As always, diversification is important.”