The CAC 40 stock index surged almost 3% as Le Pen’s opponents started strategizing on how to keep the far right out of power. Ten-year government bonds opened higher, narrowing the spread over 10-year German securities by as much as seven basis points — trimming a more than 30 basis point surge over the past two weeks.

The euro edged up, climbing as much as 0.6% to $1.0776, though still remained 0.5% weaker than where it was before President Emmanuel Macron called the snap vote in early June. Credit risk in the region plunged.

Le Pen’s party dominated the first round of voting Sunday. But Macron’s centrist alliance and the left-wing New Popular Front are now weighing whether to pull candidates from the second round to keep the far-right National Rally from securing an absolute majority on July 7. 

“The Leftist parties have indicated that they will withdraw candidates who came third in the 1st round to avoid splitting the vote next weekend,” said Jane Foley, head of FX strategy at Rabobank.

“This should limit the ability of the far-right to win an outright majority in parliament. This is providing some relief this morning, though with uncertainty high, markets are likely to remain wary,” she said.

Investors are concerned that Le Pen’s party will pursue expansive fiscal policy. 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 and its debt is expected to rise to 112% of economic output in 2024, according to the International Monetary Fund.

“While we expect some relief-tightening in OAT-Bund spreads, there is still uncertainty ahead,” said Evelyne Gomez-Liechti, a strategist at Mizuho. “Our analysis suggests that any significant tightening will be unstable given worrying debt sustainability dynamics.”

Le Pen’s National Rally locked up 33.2% of the vote, according to interior ministry figures. The New Popular Front got 28% and Macron’s coalition got 20.8%.

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.

Shares of French banks Societe Generale, BNP Paribas and Credit Agricole all jumped on Monday, while the riskiest type of bonds issued by French lenders rose the most in weeks in early trading. Banks have been under pressure since Macron called the election due to rising political risk and the drop in French sovereign bonds.

What Bloomberg strategists say…

If the leftist alliance “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.”

— Ven Ram, cross-asset strategist for MLIV

Still, strategists warn there is likely volatility ahead, as the electoral calculus gets complicated in the runoff when parties can strategically withhold candidates in certain constituencies to give a boost to a centrist hopeful.

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.

Over the past three 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. 

It’s hard to see a “material and sustainable snapback,” in French yields, 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.