The gap between French and German bond yields held near its tightest level in seven months after French President Emmanuel Macron won a commanding majority in parliamentary elections, securing a strong mandate for pro-business reforms. France's 10-year government bond yield was within sight of seven-month lows and South European government bond yields dropped on Monday after this Sunday's second round vote. Macron's centrist Republic on the Move LREM party and its centre-right Modem ally won 350 out of 577 seats in the lower house, fewer than previously forecast.
Record low voter turnout suggested France's new leader, the youngest since Napoleon, would need to proceed cautiously with reforms in a country where trade unions and street protests have in the past forced new legislation to be diluted. "He will also face an enormous amount of resistance on the ground from the vested interests of the trade unions which still wield an enormous amount of influence, and could make life very difficult for the inexperienced new President and his party," said Michael Hewson, chief market analyst at CMC Markets UK. But the scale of his victory gives Macron, a pro-European Union centrist, a solid platform to carry out his campaign promises to revive the euro zone's second biggest economy.
That lifted investor sentiment on Monday, with French stocks rallying 1.15 percent and outperforming European peers. French banking stocks, a barometer of appetite for French assets, jumped over 1.5 percent Berenberg chief economist Holger Schmieding said France could become the strongest economy in Europe in a decade. Sunday's vote also closes a chapter on what has been a driver of European market risk, given the popularity of anti-euro far-right leader Marine Le Pen heading into France's presidential elections in April and May.
The gap between French and German bond yields - an important gauge of risk appetite - had widened sharply heading into that vote but has since tightened. The 10-year bond yield gap was at 35 bps on Monday, just 2 bps away from levels hit last week that marked the tightest since November. The spread is down more than 40 bps from highs hit in February at the height of French election jitters. In absolute terms, the yield on France's 10-year government bond was unchanged on the day, staying within sight of a seven-month low of 0.58 percent hit last week.
Italian and Portuguese government bond yields dropped 3-4 basis points on the day, and the gap over the German equivalent was close to multi-month lows in both cases. These bonds tend to rally when risk appetite is strong and when euro zone break up concerns ebb. "What is also important is the composition of the (parliament)," said Peter Chatwell, head of euro rates strategy at Mizuho.
"Having the Socialists lose so many seats means this is still a very much business- and reform-friendly assembly and that's why we've been able to see the CAC-40 (stock market) rally nicely while French spreads are still relatively tight." Positive developments in French politics contrasted with turbulence in Britain, where a weakened government on Monday kicked off divorce talks with the EU.