(Bloomberg) — Investors are taking some relief from France’s election failure to produce a clear winner, believing that major policy changes are unlikely while the government remains deadlocked.
Most read articles on Bloomberg
French shares rose on Monday along with a broader rally in European markets, while bonds and the euro were only modestly moved.Reflecting persistent concerns about the country’s debt burden, spreads on benchmark bonds are still wider than before the election but have narrowed recently as the far-right or far-left are unlikely to be able to push through big spending plans.
The CAC 40 index rose 0.4%, recovering from an earlier weakness. French government bonds were little changed, with the 10-year bond yield at 3.2%. The euro stabilized after a seven-day rally to trade near 1.084 against the dollar.
“Radical reforms are unlikely and structural spending reforms are unlikely, so spreads on French government bonds will remain wide,” said Alexandre Ezez, chief investment officer at Richelieu Group. “But for other asset classes, this scenario is unlikely to cause much change.”
Read: Surprise left win in French election spooks investors
Sunday’s final vote showed the country heading for a drawn-out political battle, with investors trying to make sense of the likely outcome. The left-wing coalition will have the most power in the lower house but not enough to control the whole country. President Emmanuel Macron’s group came in second, and Marine Le Pen’s National Rally came in third.
Money managers have been worried about a Le Pen-led government for the past week or so, but a left-wing victory remains a concern for investors as it would bring new uncertainty to the euro zone’s second-largest economy.
Still, the left-wing coalition lacks an absolute majority and is limited in what it can do, and some strategists have suggested the parliamentary limbo could be a positive outcome for investors.
The spread between French and German 10-year government bond yields, a gauge of credit risk, is about 65 basis points, below the peak of last month’s market crash.
“Without a competent government to act, the situation may not be as bad as it would be, as there would be no rollback of reforms or tax cuts,” said Edgar Wolk, chief economist at Metzler.
The New Popular Front, which includes the Socialists and the far-left France Invincible party, won 178 seats in the National Assembly, according to data compiled by the Interior Ministry. Marine Le Pen’s National Rally, which was predicted to win in an opinion poll last week, came in third with 143 seats, while President Emmanuel Macron’s centrist bloc won 156 seats.
French markets plummeted in June, wiping billions of euros from stocks and bonds as fears stoked that Macron’s early elections would bring the far-right to power. But traders have pared back much of their losses over the past week as opinion polls showed his National Rally falling short of a majority. France’s CAC 40 index last week recouped about half the losses it suffered after Macron’s election announcement.
What our strategists are saying…
“The contours of the next government are still unclear, a prospect that would be an unfavourable outcome for French government bonds and put pressure on yield spreads. The key questions for markets are who will be prime minister, how well they will be able to work with the far-left to get legislation through and, most importantly, what it will mean for France’s fiscal health.”
— Ben Lamb, Cross-Asset Strategist
A left-wing majority was the scenario investors feared most in the days leading up to the first round of voting, but that possibility faded after the landslide first-round victory of Le Pen’s National Rally, which has pledged to reverse seven years of pro-business reforms and raise the minimum wage.
The Institut Montaigne estimates that the New Popular Front’s election pledges would require around 179 billion euros ($194 billion) in additional funding per year.
France is already struggling with a budget deficit of 5.5% of GDP, well above the 3% allowed under European Union rules. Without further action, the International Monetary Fund projects that debt will rise to 112% of GDP in 2024, rising by about 1.5 percentage points per year over the medium term.
S&P Global Ratings downgraded France’s credit rating in late May, highlighting the French government’s failure to meet targets in a plan to curb the budget deficit after huge spending due to the coronavirus pandemic and energy crisis.
Vincent Juvins, global market strategist at JPMorgan Asset Management, said with Macron-led reforms now in doubt, tensions were likely to rise and the value of French bonds could fall relative to other countries.
“Unless the new government provides clarity on the fiscal situation, the market may demand a higher spread,” he said. “The European Commission and the rating agencies are expecting cuts of 20-30 billion, but the government will have to negotiate with a party that actually wants a 120 billion spending increase.”
–With assistance from Vassilis Karamanis, Verena Sepp, and Greg Ritchie.
Most read articles on Bloomberg Businessweek
©2024 Bloomberg LP
