10:35 AM EDT, 06/24/2024 (MT Newswires) -- It has been a "dramatic" two weeks for the European debt market with French President Emmanuel Macron calling snap elections after his party's defeat in the European Parliament election against the far-right, noted ABN Amro.

This created high political uncertainty and turmoil in the eurozone government bond (EGB) market but particularly in the French market, wrote the bank in a note to clients. The legislative election will take place in two rounds with the first round scheduled this Sunday and the second round on July 7. This election is "crucial" as it will elect the 577 members of the national assembly that will decide on government policy for the upcoming three years.

The French snap election triggered a flight to quality in Europe, with the government likely to lose, stated ABN Amro.

Various polls suggest a win for the radical parties over the centrist government, which might lead to three different scenarios in ABN Amro's view:

-- Scenario 1 (Far-right in power - Base case): The far-right gains a (relative) majority but most of its political program wouldn't be possible to implement in those three years. Although the bank expects fiscal deterioration under this government, this should remain limited assuming the party doesn't want to trigger a debt crisis, which would scupper its chances of gaining full power in the 2027 election;

-- Scenario 2 (Far-left in power - Negative): The most worrying scenario in terms of the economic and fiscal outlook would be a government led by the left coalition. Their political and economic program appears more radical than any other party and would create significant distrust in the market;

-- Scenario 3: (Hung parliament - Benign): None of the three political blocs obtain a clear majority, putting the government on hold for at least a year. This wouldn't be a positive outcome, but it would at least mean no further deterioration in government finances, in contrast to the two scenarios above.

Accoridng to ABN Amro, one thing is clear: in any of the possible scenarios described, France's fiscal deficit is unlikely to go back to the 3% deficit target by 2027 as promised by the current government.

The French political turmoil has also disrupted the calm in the European debt market, pointed out the bank. French bonds have underperformed significantly since the announcement of the snap election.

This also had spillover effects to other EGBs, particularly on southern eurozone countries as their borrowing costs are historically closely correlated with France's 10-year OAT, added ABN Amro.

As such, the bank predicts the 10-year OAT-Bund spread to remain high until there is more clarity regarding the outcome of the election and subsequent policies for the next three years.