French election: How are we left?

The government bond investor view – Gareth Hill, Government Bond Senior Fund Manager

On one level, the result of the second round of the French Legislative Elections was in line with market expectations; going into Sunday’s vote, the overwhelming expectation was that no one single party would emerge with a majority, and the likely outcome (with a probability of around 85%) was that there would be a hung parliament.

The expectation was that, within this, the right wing party fronted by Marine LePen, National Rally (RN) would have the most number of seats and would therefore be well placed to influence policy going forwards. Markets had been calmed by conciliatory commentary from RN, who had reigned back from some of their more expensive policies and had pledged to respect the fiscal framework laid down by the EU, akin to the approach taken by right wing prime minister, Giorgia Meloni in Italy. In the run up to the second round, the spread over France 10-year government bonds versus their German equivalents contracted by 15 basis points(bps) from the wides seen immediately after the snap election was announced at the end of June, when the spread had increased by around 30bps.

However, the second round vote did not go as expected, with RN coming in third place, behind the centrist party of Emmanual Macron (the incumbent president), with the surprise of the night being the left-wing party of the New Popular Front (NPF) winning the highest number of seats. In the run up to the elections, the NPF was seen as the least “market friendly” party, as they maintained their commitment to fiscally expansive policies, putting them on a collision course with the EU and sovereign debt rating agencies. France is already facing significant fiscal challenges, something which Macron had been trying to address – perhaps explaining his party’s poor showing in the European parliamentary elections – and the final result of the French elections is unlikely to help their cause.

So how has the market reacted? After an initial widening of the spread versus Germany (French bonds underperforming), the yield premium of France over Germany has subsequently tightened. The market is perhaps taking the view that with such a broad coalition (the NFP is actually made up of Socialists, Greens, Communists and the France Unbowed party) means that it will be difficult to arrive at an alliance between the minority parties, and the cost of doing so is likely to involve a severe watering down some of the NPF’s pre-election pledges. The next few days, or even weeks, are likely to see a lot of political horse trading as the various parties try to come together to find enough common ground to form a government. It is this compromise that the market is trading on – a potentially ineffectual government that, whilst unlikely to put France on a path to fiscal consolidation that the EU would like to see, is also unlikely to be able to implement the aggressive fiscally expansive policies that the market had feared. We do not expect the France / Germany spread to return to its pre-election levels, and in the medium term we could well see it drift wider as the market begins to price a potential re—rating of French debt, given the potential headwinds that exist arising from concerns over economic growth, debt sustainability and political instability.

The asset allocator view – Hiroki Hashimoto, Multi Asset Senior Fund Manager

Macron’s and the left coalition’s effort to contain the Le Pen’s National Rally (RN) has worked better than the polls suggested, leading to a hung parliament with RN coming in third. Investors were more focused on the French elections than the UK election, given the greater policy differences between the main parties in contention. This outcome has led to a modestly positive market reaction in European equities this morning, perhaps partly reflecting that the historically euro-sceptic RN did not get a majority. Additionally, a hung parliament seems likely to limit the left-wing agenda on tax and spend, despite the left coalition securing the most seats.

This is likely to be positive for equities for now, which can continue to climb the wall of political worry while their advance is supported by corporate earnings. US equities still look brighter compared to European equities based on the fundamentals.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.