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(Bloomberg) — The euro rose as traders digested signs Marine Le Pen’s far-right party was poised to win the first round of France’s legislative election with a smaller margin than some polls had indicated.

The common currency climbed 0.2% to $1.0740 in early Asia trading, the strongest since Tuesday.

Initial projections showed Le Pen’s far-right party in front of President Emmanuel Macron’s centrist alliance and the left-wing New Popular Front — but with potentially fewer votes than it needs to secure an absolute majority after a second round of voting.

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The market has been concerned that a very strong showing for Le Pen’s National Rally will increase the odds of expansive fiscal policy, bringing the nation’s bloated fiscal accounts sharply into focus and further muddying the outlook for the common currency.

The focus now turns to whether her party can garner enough support in the second round of voting on July 7 to get an absolute majority in the National Assembly, which would allow it to pass legislation more easily. President Macron and her other opponents are already strategizing to keep the far-right party out of power.

“We now have a week of horse-trading ahead of us,” said Joachim Klement, head of strategy, accounting and sustainability at Liberum Capital, who expects the euro to strengthen through the week as alliances are formed to reduce the gains of Le Pen’s party.

What Bloomberg strategists say…

If the leftist alliance is “is aimed at blocking Le Pen’s grouping from getting a majority in the crucial second round, it has wide-ranging implications for the France-German spread and indeed the euro. If the upshot is that we will get a more centrist government, it would be positive for the currency and herald a narrower spread.”

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— Ven Ram, cross-asset strategist for MLIV

The National Rally was projected to get between 33% and 34.2% of the vote, according to initial projections from four polling companies on Sunday. Bloomberg’s final poll of polls on Friday put them at 36.2%.

The left-wing alliance was set to get between 28.5% and 29.6% of the vote and Macron’s centrist alliance between 21.5% and 22.4%, projections on Sunday showed.

If alliances forming to block Le Pen from absolute power start to look credible, French markets would likely recover, according to Kathleen Brooks, research director at XTB.

“A hung parliament could make it hard to get anything done in France in the current parliament, which is exactly what the markets would like,” she said.

Macron’s decision to call a snap vote in early June had sent markets into a tailspin. 

His party — which supports large spending cuts to get France’s budget deficit under control — suffered a crushing defeat in European parliamentary elections. National Rally, meanwhile, has touted some costly budget measures including lowering the sales tax on energy and fuel.

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Over the past two weeks, the extra yield investors demand to hold 10-year French bonds over safer German debt rocketed to more than 80 basis points, levels last seen during the euro area’s sovereign debt crisis. The euro fell to its lowest since early May. 

Fiscal Pressures

While the 10-year yield spread may find some relief as trading starts on Monday, it’s hard to see a “material and sustainable snap back,” said Peter Goves, head of developed market debt sovereign research at MFS Investment Management.

“Uncertainties are high, French fundamentals haven’t changed and the final outcome is still unknown and unknowable with the large number of three-way contests complicating matters,” he said.

At a projected 5.3% of output this year, France’s budget deficit already far exceeds the 3% of economic output allowed under European Union rules. The International Monetary Fund predicts without further measures, debt would rise to 112% of economic output in 2024, and increase by about 1.5 percentage points a year over the medium-term.

French bond futures start trading at 1:10 a.m. London, followed by cash bonds at 7 a.m. and stocks at 8 a.m.

—With assistance from Allegra Catelli.

(Updates with additional comment.)

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