The French stock market is breathing heavily in response to the election results, which are spreading to the rest of Europe

The market received with some complacency the result of the first round of the French legislative electionsThe CAC index rebounded by 1.09% and led, together with the Italian Mib (1.7%), the rises in European stock markets, with banks driving their recovery, while the French risk premium fell to 74 basis points, although it remains at its 2017 highs.

The victory of Marine Le Pen’s National Rally (RN), which won 33.1% of the vote, ahead of 28% for the New Popular Front (NFP) and 22% for Emmanuel Macron’s Ensemble coalition, does not clear up France’s political future but, for the moment, it removes the worst-case scenario. “The result reduces the risk that the far left or the far right can implement extreme policies, but points to a possible political paralysis that will slow down reforms in the coming years,” explain the analysts at Jefferies.

With the extremes out of the way, investment banks are once again making their guesses, and few are sticking to one option. At Citi, they see two possible scenarios after the second round of voting on Sunday: an absolute majority for Le Pen’s party or a deadlocked parliament. UBS adds to these alternatives a minority government, either of the RN or the NFP, which would, in any case, leave an unstable scenario, with very limited political visibility and with “a substantial loss of influence in Europe.”

Jefferies is betting on a Le Pen victory, but far from an absolute majority. “Whether the National Rally is able to form a government will depend on how close it gets to an absolute majority. If it comes within 20-25 seats (of the required 289), it should be able to form a minority government,” the US investment bank notes.

However, analysts are wary of getting carried away. “France’s fiscal outlook is already worrying, with debt to GDP at over 110% and a deficit at 5.5%. The lack of reforms means it is likely to remain above the EU’s 3% target even after five years,” Jefferies estimates.

Citi believes that a correction of between 5% and 20% in the French stock market is possible if one of its two scenarios materialises, although it believes that the market is discounting a scenario of a standstill, with an executive led by Le Pen but a “benign” fiscal impact. “An indecisive parliament is far from being politically ideal, but it is not necessarily the most unfavourable outcome for the market,” acknowledges Peter Goves, head of sovereign debt analysis for developed markets at MFS Investment Management.

For now, the CAC has lost 5.5% since Macron called the legislative elections on June 9, although with today’s gains it is back in the black for the year. In this time, the Euro Stoxx 50 has lost 2.4%, while the German Dax has lost 1.4% and the Ibex 35 has lost 3%.

The financial institutions have been the ones to beat, and have partially offset the fall. BNP Paribas rose 3.59% on the stock market, followed by Société Générale, which gained 3.1% and Credit Agricole, which gained 2.83%. The energy company Engie also gained 2.96%, followed by Airbus (2.83%).

No rush to buy

Despite the strong punishment recorded by the French stock market leaving attractive valuations, Jefferies analysts believe that it is too early to buy into its recovery: “We see a new rebound in risk assets after the second round of elections, but we are more positive on American and European names rather than French names,” they emphasize. Citi is also showing no respite, where they believe that the banking sector will continue to be under pressure throughout this week.

MFS is sceptical about a possible sustainable recovery in French debt, stating that “uncertainties are high, French fundamentals have not changed.” However, they believe that contagion to the periphery of the European Union should be limited.

At UBS, however, they believe that “the arguments for the resilience of French bonds remain compelling, given not only the disinflation and modest growth in the euro area, but also a broad institutional investor base, a long-term maturity profile and a relatively low proportion of French debt held by banks.” According to their calculations, in the worst-case scenario, the French risk premium would reach 130 basis points. Today it closed at 74 basis points.

Julius Baer rejects the possibility that an increase in the risk premium could lead the ECB to adopt extraordinary measures, maintaining its preference for peripheral debt, including Italian debt, over that of countries such as Germany.