Poster by Christophe Versini for the Rassemblement National (National Rally) party, featuring Marine Le Pen and Jordan Bardella, on June 24, 2024.
Magali Cohen | Episode | Getty Images
The sell-off in French stocks and government bonds after President Emmanuel Macron called a shock parliamentary election may have subsided – but investors remain spooked ahead of Sunday's vote, with some warning of a possible debt crisis.
Recent poll suggests that the far-right party Rassemblement National (RN, or National Rally), led by Jordan Bardella, could win the most seats in the National Assembly, followed by the left-wing alliance Nouveau Front Popculaire (NFP, or New Popular Front).
The centrist alliance — with Macron's own Renaissance Party — is seen third. The first round of voting on Sunday will be followed by a second round on July 7, and could result in a vote-starved parliament.
This uncertainty – combined with policy promises from both the left and the right – now hangs over the markets.
The blue chip of the country CAC40 The index is heading for the worst month since May 2023, as far as the big banks are concerned Societe Generale And BNP Paribas down nearly 19% and 11% so far in June.
Yields on French government bonds – which develop in the opposite direction to prices – have remained relatively limited. But market observers have highlighted France's borrowing costs relative to those of its neighbors, especially Germany. The spread between French and German 10-year yields has grown to more than 71 basis points since the vote, the widest in more than a decade, as investors bet Germany is less risky.
National Rally “has been busy moderating its policy stance on all fronts – in a nod to the playbook that got Giorgia Meloni elected in Italy in 2022,” Viraj Patel, senior strategist at Vanda Research, said in a note on Wednesday note.
While the initial sell-off in French shares was driven by fears of populist measures by Rassemblement National, “it is precisely the measures of the newly formed left-wing alliance that have caused more turmoil in the markets in recent days,” Patel added.
These include raising the minimum wage, freezing the prices of some essential necessities for low-income households, and changes to income tax brackets.
Both parties have expressed a desire to reverse Macron's decision last year to raise the state pension age – although RN has done so recently withdrawn of this – and said they will offset some of their higher spending by raising taxes on the rich.
Liz Truss style event
Several analysts have warned that budget proposals from both the left and right could trigger a Liz Truss-style market crisis.
Truss, who was Prime Minister of Great Britain for 45 days in 2022, shocked the markets with a a wide range of tax cuts and no reduction in government spending to finance them. The fallout led to a violent reaction in the bond market that eventually led to central bank intervention, reversing almost all policies, and ultimately Truss's resignation.
Andrew Kenningham, chief Europe economist at Capital Economics, last week outlined some possible election outcomes and their market implications.
At best, a centrist or technocratic government would be “cobbled together,” he said, or the RN or NFP would significantly scale back their plans when faced with the reality of forming a government. Even then, he added, the spread of French bond yields versus their German counterparts appeared to remain wider than before Macron called the election.
“The worst case scenario is a full-fledged bond market and a budget crisis,” Kenningham continued.
This would result in the RN or NFP forming a government, implementing most of their campaign promises and rejecting the European Union's fiscal rules – which Kenningham estimates could widen the gap between French and German 10-year yields to 300 basis points.
“History suggests this would force the government's hand [to] change direction or resign,” he said, as in the case of Truss, the Italian government in 2018, and French President François Mitterrand in 1983.
“The [European Central Bank] would be reluctant to come to France's aid itself unless and until a future government puts forward a credible plan to reduce the budget deficit. But if interest rates spiral out of control, the bank could also be forced to intervene, just as the Bank of England did after Britain's mini-budget.”
Debt pile
In another parallel with Britain, the recent drama in French politics and financial markets is compared to that following the 2016 Brexit vote, which hit British assets with a higher risk premium.
“The comparison with Britain is interesting because in both cases you had a sudden decision to force voters to make a decision, and that scares the markets,” Christian Keller, head of economic research at Barclays, told CNBC's “ Squawk Box Europe”. .
There is little concern that France will introduce its own 'Frexit', he said, with even National Rally having moved away from actively proposing to leave the eurozone or the European Union.
“But it is certainly a concern about fiscal developments in France… the country has a debt ratio of 110%, France has no history, no track record when it comes to adjusting the budget deficit,” Keller added.
Macron has made a number of attempts to reduce the country's mountainous areas 3 trillion euros (3.2 trillion dollars) debts are piling up, partly due to the reform of the retirement age, but nevertheless the government deficit 2023 increased.
“We remain skeptical about French debt,” Keller said, noting this is because investors are looking more favorably at Britain ahead of its own general election.
For Beat Wittmann, chairman of Porta Advisors, the recent turmoil in French assets presents a good opportunity for investors to buy in. Despite uncertainty about the outcome, the vote and election process will ultimately be orderly and democratic, he told CNBC. last week.
“We see that sentiment is obviously having an impact on the French stock market, it has fallen, the spread against bunds has widened – but I think this is a great entry point because ultimately it depends on what the elections are. ” politicians and the leaders will do it or not,” Wittmann said.
“The markets are already teaching them a lesson in advance, so I think this is a great starting point.”
