French leftist election victory did not soothe nervous investors

French leftist election victory did not soothe nervous investors


The shock election win of France's left-wing coalition has fueled anxiety among investors already bracing for the risk of political deadlock and policy paralysis that is unlikely to improve the country's crumbling public finances.

The left-wing New Popular Front (NFP) alliance won the most seats in Sunday's election but fell far short of an absolute majority, a major surprise after Marine Le Pen's right-wing National Rally (RN) had taken a lead in opinion polls.

France, which is at the heart of the euro project and has the EU's second-largest economy, still faces instability in parliament and talks to form a government are proving difficult, just as markets had predicted – only the left is in power, not the right.

The risk premium, or spread, for holding French debt over German debt was 65 basis points on Monday, down slightly from Friday. It remains below a 12-year high of 85 basis points hit in June.

Still, the gap is not expected to close quickly again, as concerns remain over how France's new political climate will impact its strained public finances, which have left it facing EU disciplinary measures.

In 2023, debt will be 110.6% of output.

“For the new legislature to pass any budget, there will probably need to be some level of fiscal easing to reach a compromise,” said Kevin Zhao, global sovereigns and currencies head at UBS Asset Management, which manages $1.7 trillion in assets.

The market's respite on Monday proved temporary. France's main CAC 40 stock index, which was down 3.7% since Macron announced the election, rose as much as 0.8% on Monday before losing all its gains.

Shares in France's three biggest lenders – BNP Paribas, Societe Generale and Credit Agricole – have fallen as much as 9.8% since June 9, and have also reversed earlier gains and were down 0.4%-1.2% at 1418 GMT.

Banks had suffered heavy losses ahead of the vote amid concerns that heightened political uncertainty would increase economic risks and raise fears of potential unexpected tax bills.

With the left more than 100 seats short of an absolute majority and President Emmanuel Macron's centrist party in second place, an unstable parliament was still seen as the best outcome for investors in French assets, and was expected to limit leftist spending plans and avert a potential budget-induced market crisis.

The NFP's plans include repealing Macron's pension reform, raising the minimum wage, and placing a cap on the prices of key commodities.

He says the cost of his program will be covered by other measures, including tax increases.

But some investors had viewed the NFP's absolute majority as a bigger threat to markets than the RN, after the left-wing coalition said it did not plan to reduce France's high budget deficit.

“When you look at the composition of parliament, you find that the far-left is much more likely to do anything that is anti-market,” said Gabriel Foa, a portfolio manager at Algebris Investments. He noted that more moderate socialists won a large share of NFP seats.

Possibilities for a new government include the NFP forming a minority government, Macron splitting the Socialists and Greens from the NFP and forming a coalition with Jean-Luc Mélenchon's far-left France Unbowed or forming a technocratic government with his own bloc.

No relief

Still, investors did not view the instability in parliament as good news for France's public finances and expected the country's budget deficit – which stood at 5.5% of output last year – to remain high.

Mélenchon said the NFP would implement its programme, while Socialist leader Olivier Faure said Mr Macron's pension reform must be scrapped.

S&P Global Ratings warned on Monday that France's credit rating, which it recently downgraded, would come under pressure if economic growth remains lower than expected or the budget deficit cannot be reduced.

Analysts do not expect the French/German bond differential to return to the levels of around 50 basis points seen before Macron announced the election.

“Going back to French debt would mean we would get guarantees from the government that they are making good decisions to restore fiscal and budgetary balance,” said Mathieu de Clermont, head of insurance and regulatory strategies at Allianz Global Investors.

“I'm not sure we'll get it anytime soon.”

Some investors said the France-Germany gap could widen again if uncertainty persists, raising the cost for France to borrow from international bond markets compared with its neighbours, which could increase pressure on the budget.

“The biggest risk, apart from the near-term headlines, is what happens in the negotiations with the EDP and the European Commission,” said James Ringer, a fund manager at Schroders, referring to the EU's budgetary discipline measures.

Investors remain cautious on French assets as they say it is too early to predict what the new government will be like. The risk of another election within a year cannot be ruled out.

“It will probably take weeks or months for Macron and others to sort out their alliances,” said Anders Persson, global fixed-income head and chief investment officer at Nuveen, which manages $1.2 trillion in assets.

He is still underweight French government bonds.


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