French Elections Preview: Euro to “sell the fact” on a hung parliament scenario

• Investors expect Frances's second round of parliamentary elections to end with a hung parliament. 
• Keeping extremists out of power is priced in and could result in profit-taking on Euro gains.  
• A surprise victory for Marine Le Pen's National Rally would send the common currency plunging.

Are investors basking in the summer fun too soon? The French are going to the polls while organizing their annual vacances and markets seem calm ahead of the second round of parliamentary elections. This calm may create an opportunity.

Here is a preview of the French elections due on Sunday, July 7.

France is Europe's second-largest economy and the only nuclear power in the European Union. Markets adore centrist President Emmanuel Macron and his reforms – but his compatriots beg to disagree.

Macron's approval rating. Source: Politico

His centrist party came out third in the first round, while Marine Le Pen's far-right National Rally came on top, receiving nearly a third of the votes. 

France has a complex electoral system, making it difficult for pollsters and political analysts to assess the outcome. Nevertheless, there is an optimistic scenario stemming from the fact that many candidates retired in an effort to stop the far-right.

Macron's centrists and the New Popular Front – itself comprised of four parties – have agreed to let the leading candidate in each constituency remain in the race against Le Pen's person. While not all candidates obeyed, hopes of halting have risen.

According to some estimates, the National Rally will obtain no more than 240 or 250 seats in parliament, short of the 289 needed for a majority. The division of seats among of the 577-strong Assemblée nationale (as the French parliament is called) will be known as markets open in Asia. 

French second round market positioning

The Euro has been advancing as the optimism of halting the Le Pen victory has increased. A scenario of a hung parliament – which could result in a technocratic harmless government – is already in the price.

I expect the common currency to decline on a "buy the rumor, sell the fact" response, declining from the highs. Such an impact may be short-lived, until other factors return to impact the Euro.

Later, a government which comprises Macron's centrists, the center-left Socialists and the center-right Republicans would be the best outcome and could lift the currency. A do-nothing technocratic government would be ignored. 

There is another scenario in which the far-right does achieve a majority if center-right or extreme-left voters give Le Pen's party a chance. Such an outcome would shock markets after a sanguine week. In such a case, global stock markets would suffer, and the Euro would plunge.