Second round of French legislative election brought new surprises on the table

The second round of French legislative election brought new surprises on the table – to say the least. Not only Marine Le Pen’s far-right National Rally didn’t win a majority but the New Popular Front – which is a leftist coalition led by the far-left Jean Luc Melonchon – secured the biggest share of the cake, and did too well to soothe investors’ concerns regarding stability and the predictability of the French politics and the good health of the French finances as Melonchon likes to spend big – probably even more than the far-right, he is anti-euro and anti-NATO. Melonchon said after the results that he will stick to his huge spending plan entirely and refuse to enter in parliamentary discussions with Macron. The latter  could weigh on French bond appetite and keep the spread with the German yield above the pre-election levels and limit the euro’s upside potential.

The market reaction was a swift fall in the euro at the open, the franc gained on the back of an early flow of capital to its safety, but the EURUSD recovered most of losses before the Europeans have stepped in. The EURUSD trades around 1.0830 level at the time of writing. The European equity futures were pointing to the upside when I first turned on my computer but are slightly negative right now as the French political risks are not gone. France went from favouring the far-right to giving support to the far left in just a week time. French are looking for solutions in two extremes and that’s not an ideal outcome.

In equities, shares of French banks will particularly be in focus as the left suggested raising banks’ mandatory capital buffers and transaction tasks, and will also be tempted to raise taxes on wealth, dividends and share buybacks.  

Soft jobs data fuels Fed cut bets

Across the Atlantic, last week ended with heightened hope of Federal Reserve (Fed) rate cuts. Despite a higher-than-expected NFP number, the wages growth eased in line with expectations while the unemployment rate ticked higher – to the highest level since late 2021. As such, investors looked past the stronger-than-expected NFP figure and sent the US yields lower. The US 2-year yield fell to 4.60% and the 10-year yield slipped below 4.30% as the probability of a September rate cut jumped past 75%. The dollar index extended losses below the 50-DMA and is preparing to test the 100-DMA – which stands near 104.75 - to the downside, though the US dollar is better bid this morning as a result of more political shenanigans in France.

Later this week, Fed Chair Jerome Powell’s semiannual testimony and the release of the all-important US CPI update will take the center stage. On Tuesday and Wednesday, the Fed Chief will likely reiterate the progress in inflation and may even give a clearer hint on the approximate timing of the first rate cut. And on Thursday, the latest inflation report from the US is expected to reveal a softening headline CPI from 3.3% to 3.1%, and a steady core reading at 3.4%. The market is craving for a set of soft and ideally softer-than-expected inflation numbers to bring the Fed closer to lowering its rates.

In equities, the rising Fed rate cut bets and lower yields helped the S&P500 close the week on a positive note, having reached another record high level on Friday. As such, the index kicked off the H2 of the year with its strongest performance since late April and climbed 2% during last week. Nasdaq 100 also extended gains toward new highs and closed a touch below the 20400 mark while the Russell 2000 traded lower on Friday and failed to extend gains above its 50-DMA – as a warning that the major US indices don’t necessarily reflect the mood elsewhere. The Russell 2000 is down by more than 5% since the April peak and the slowing economic fundamentals worry the small cap investors more than they worry the big caps.

Elsewhere, US crude fell more than 1% on Friday and begins the week downbeat after last week’s failure to clear the $85pb resistance. The price of a barrel stands at the bottom of the ytd uptrending channel base and should see the benefits of rising Fed cut bets. A minor support to the latest rebound is seen at $81.85pb – the 23.6% Fibonacci retracement on past month’s rebound. A major support is seen near the $80pb psychological level – which also coincides with the major 38.2% Fibonacci retracement and which should distinguish between the actual positive trend and a medium term bearish reversal.