Euro, European equities rally, but French election tempest far from over

Yes, Mesdames et Messieurs, the first round of the French legislative election went totally according to the plan for Marine Le Pen’s Nationally Rally which secured one vote over three and became the first far-right party to top the legislative elections in France. The New Popular Front – the alliance of left and greens - won 28% of the votes and Emmanuel Macron’s party posted a miserable 20%. The second round is due next weekend.

The kneejerk reaction was a jump in the euro in the early week trading. The EURUSD jumped past 1.0750, the euro-pound flirted with the 0.85 level and the European futures trade in the positive as a ‘buy the rumour sell the fact’ reaction to the election outcome - and also on chatter that National Rally may not secure an absolute majority in the second round. But there is a non-neglectable chance for Marine Le Pen and Mr, Bardella to win the parliamentary majority next week and that risk will unlikely let the euro run too high before more clarity.

The spread between the French and German 10-year yields topped 80bp last week, a level that has not been seen since the European debt crisis back more than a decade ago. But the French-German spread has room to widen and a Le Pen majority could revive that demon.

Across the Channel, the week starts with increased election vibes as well, because Brits will be headed to their own general election this Thursday with little suspense on the horizon. A Labour win is seen as a net positive for financial markets, and would benefit to banks, homebuilders and groceries the most according to JP Morgan. A Labour should also benefit to the British pound in the long run on hope of improved relations with Europe post- Brexit. In the short run, however, a Labour win is broadly priced in. Therefore the return of the Bank of England (BoE) doves following the election could keep the pound’s upside potential limited. Cable trades around its 50-DMA this morning and may not clear the 1.28 offers even after the election dust settles.

Good news from the data front

Released on Friday, the US core PCE slowed as expected in May as personal spending fell short of expectations. Combined to Thursday’s soft GDP number, last week’s US data was supportive of the Federal Reserve (Fed) doves. The S&P500 hit a fresh record, though closed the session in the negative.

But looking back, the S&P500 and Nasdaq had a stellar H1 thanks to the extension of the tech rally. It would be healthy to see the rally broaden to other sectors provided that the narrow breadth increases the risk of sudden and sharp selloffs. According to Bank of America, the algorithmic models boosted their exposure to technology to such extent that the stop-loss triggers became very tight. In numbers, the commodity trader advisors, so the automated trade models, can start unwinding their long positions when the US futures drop 2.8% or more, while this threshold was at 4% a month ago. This means that the margin for a misstep becomes narrower and the risk of long squeeze rises as the major US indices travel through uncharted territories on the shoulders of just a few tech names that are probably overpriced.