Poster of Christophe Versini for the Rassemblement National (National Rally) party, with Marine Le Pen and Jordan Bardella on it, on June 24, 2024.
Magali Cohen | Afp | Getty Images
The sell-off in French stocks and government bonds after President Emmanuel Macron called a shock parliamentary election may have eased — but investors remain spooked ahead of Sunday’s vote, with some warning of a potential debt crisis.
Recent polling suggests the far-right Rassemblement National (RN, or National Rally) party, led by Jordan Bardella, could win the most seats in the National Assembly, followed by the left-wing alliance Nouveau Front Populaire (NFP, or New Popular Front).
The centrist alliance — containing Macron’s own Rennaissance Party — is seen coming third. Sunday’s first-round vote will be followed by a run-off on July 7, and could result in a hung parliament.
This uncertainty — combined with the policy pledges of both the left and right — now hangs over markets.
The country’s blue-chip CAC 40 index is heading for its worst month since May 2023, with major banks Societe Generale and BNP Paribas lower by almost 19% and 11% so far in June, respectively.
French bond yields — which move inversely to prices — have been relatively contained. But market-watchers have highlighted France’s borrowing costs versus its neighbors’, particularly Germany’s. The spread between French and German 10-year bond yields has grown to more than 71 basis points since the vote was declared, its widest in more than a decade, as investors bet Germany is lower risk.
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 back in 2022,” Viraj Patel, senior strategist at Vanda Research, said in a note on Wednesday.
While the initial sell-off in French stocks was driven by fear of populist policies being introduced by Rassemblement National, “it’s the policies of the newly formed left-wing alliance that has caused more of a stir for markets in recent days,” Patel added.
Those include raising the minimum wage, freezing the prices of some essentials for low-income households, and changes to income tax brackets.
Both sides have expressed a desire to reverse Macron’s move last year to raise the state pension age — though RN has recently backed away from this — and said they will offset some of their higher spending by increasing taxes on the wealthy.
‘Liz Truss-style’ event
Several analysts have warned that the fiscal proposals of both the left and right could spark a “Liz Truss-style” market crisis.
Truss, prime minister of the U.K. for 45 days in 2022, shocked markets by announcing a vast array of tax cuts and no reduction in public spending to fund them. The fallout sparked a violent bond market reaction which eventually led to a central bank intervention, almost all of the policies being reversed, and Truss’ eventual resignation.
Andrew Kenningham, chief Europe economist at Capital Economics, last week outlined some possible election outcomes and their market implications.
A best-case scenario would see a centrist or technocratic government being “cobbled together,” he said, or the RN or NFP majorly scaling back their plans when faced with the reality of forming a government. Even then, he added, the spread of French bond yields over their German counterparts looked set to remain higher than before Macron called the election.
“In the worst case there is a fully-fledged bond market and fiscal crisis,” Kenningham continued.
This would see either the RN or NFP forming a government, implementing the majority of their campaign pledges and rejecting the European Union’s fiscal rules — which could push the gap between French and German 10-year yields up to 300 basis points, according to Kenningham.
“History suggests this would force the government [to] change direction or resign,” he said, as in the cases of Truss, Italy’s government in 2018, and French President François Mitterrand in 1983.
“The [European Central Bank] would be reluctant to come to the rescue of France itself unless and until any future government put in place a credible plan to bring the deficit down. But if yields were spiraling out of control it could also be forced to step in, just as the Bank of England did after the U.K.’s mini-budget.”
Debt pile
In another parallel with Britain, the recent drama in French politics and financial markets has been likened to that following the Brexit vote in 2016, which saw U.K. assets hit with a higher risk premium.
“The comparison to the U.K. is interesting because in both cases you had a sudden decision to force voters to make a decision, and that spooks markets,” Christian Keller, head of economics research at Barclays, told CNBC’s “Squawk Box Europe” last week.
There is little concern over France enacting its own “Frexit,” he said, with even National Rally having moved away from actively proposing leaving the euro area or the European Union.
“But it is certainly a concern about fiscal developments in France … the country has a 110% debt to GDP ratio, France has no history, no record of being able to adjust the fiscal deficit,” Keller added.
Macron has made some efforts to reduce the country’s mountainous 3 trillion euro ($3.2 trillion) debt pile, including through pension age reform, but the public deficit nonetheless increased in 2023.
“We continue to be skeptical on French debt,” Keller said, noting that it comes as investors are looking more favorably on the U.K. ahead of its own general election.
For Beat Wittmann, chairman at Porta Advisors, the recent turmoil in French assets presents a good opportunity for investors to buy in. Despite uncertainty about the result, ultimately the vote declaration and the election process is set to be orderly and democratic, he told CNBC last week.
“We see that sentiment is of course affecting the French stock market, it has been down, the spread relative to bunds has been widening — but I think that’s a great entry point, because at the end of the day, it depends what the elected politicians and the leadership will do or not do,” Wittmann said.
“The markets are teaching them a lesson ex-ante already, so I think it’s a great entry point.”