The Strategist

Macron's gamble risks plunging Europe into crisis

The French president’s decision to call early parliamentary elections has sent shock waves through Europe and rattled financial markets. France’s national debt has been a headache for the country and the European Union for some time. The prospect of France’s far-right or a left-wing coalition - campaigning on platforms of increased public spending and euroscepticism - winning a majority in parliament is now straining relations with the EU and has triggered sell-offs in bond and equity markets. 

Date
Auteur
Antonia Strachwitz, LGT
Temps de lecture
10 minutes
French Elections
© Shutterstock

A new risk to the global economy has emerged, and it comes from the heart of Europe. Following his party’s poor showing in the recent European elections, French President Emmanuel Macron has dissolved the National Assembly (NA) and has called early parliamentary elections. The first round of voting will take place on 30 June and the second on 7 July. Macron is making a high-stakes gamble that voters will once again reject right-wing candidates when faced with a stark choice, and that his party will be able to consolidate centre-right and centre-left voters in France's two-step voting process. However, current polls suggest that this could give the far-right Rassemblement National (RN) party significant power in the French legislature, possibly even complete control of it. France’s finance minister, Bruno Le Maire, has warned that the country risks a national debt crisis if Le Pen's party implements its expensive fiscal and protectionist "France first" agenda. The proposed policy framework could trigger a "Liz Truss-style" financial crisis, adding to the country’s already critical budget deficit and threatening European unity. 

A political stalemate in one of the staunchest defenders of the European Union?

Perhaps more important than the short-term impact of a populist government on fiscal and other policies is France’s crucial role in the broader European project. The Franco-German partnership has been at the heart of the European Union for years. A eurosceptic party coming to power in either country could lead to significant destabilisation. However, the RN no longer proposes to leave the Union and the euro area, instead proposing to restrict the free movement of migrants through national border controls and to roll back EU climate rules. Relations with the EU and other partners may therefore not change dramatically in the immediate aftermath of the elections. Moreover, even if the RN wins an absolute majority in parliament, Macron would retain constitutional power over relations with Europe, foreign policy, and defence.

The French electoral system's two-round voting process outcome makes it particularly difficult to predict the outcome of the elections. Yet, if the polls are to be trusted, the RN could secure a significant increase in seats, while Macron’s camp is set to suffer a similarly significant loss. 

Among the possible outcomes, an absolute majority for the RN would bring the most dramatic changes, with the party appointing a prime minister and passing some of its proposed laws and policies aimed at increasing public spending on pensioners and households, while reducing funding for immigration. A situation in which the president and prime minister come from rival political parties, a so-called "cohabitation", has only occurred three times in the 5th Republic and carries the risk of political paralysis. Relative majorities for the RN or the country's left wing - which has seen a significant rise in popularity and is polling just below the RN, at 27% - could also throw France into political deadlock. If Macron's party manages to retain its relative majority against the odds, France would remain stuck in the status quo of struggling to form alliances to pass policies on competitiveness, funded through widely resented labour reforms and local government austerity. 

Whatever the outcome of the elections, France's fiscal position will remain challenging under EU rules, which should limit any government's fiscal room for manoeuvre. 

Fears of impending debt crisis will keep volatility high

The prospect of either the left-wing coalition or the RN winning a parliamentary majority on a platform of unfunded public spending has unsettled financial markets and triggered sell-offs in bond and equity markets. French government borrowing costs have soared since Macron’s announcement. France now pays a higher interest rate than Portugal and its credit outlook is deteriorating. In May, S&P had already downgraded the country’s long-term credit rating to AA-. Further downgrades of one notch over the next 12 to 24 months are expected, higher deficits than currently anticipated could lead to earlier or even more downgrades. The yield spread between French and German ten-year sovereign bonds posted its biggest weekly increase since late 2011, during the eurozone sovereign debt crisis, and is at a ten-year high of 77 basis points. These developments have prompted some market talk of possible ECB intervention, although ECB policymakers were reportedly not planning to discuss activating emergency bond-buying mechanisms to support French debt. 

French corporate bonds are less volatile than government bonds and are not expected to be significantly affected by the elections. Financial stocks, on the other hand, have been among the hardest hit amid concerns about the RN and the left-wing coalition’s proposed spending increases and their impact on the deficit. Political uncertainty tends to negatively impact equities, as higher bond yields and political risk premiums weigh on the market. The financial sector has been particularly affected, with banks and insurance companies being penalised. They hold large portfolios of government bonds and a populist government is expected to try to introduce more windfall taxes, restrictions on dividends and share buybacks. The CAC 40 fell 6% last week, its biggest weekly drop since March 2022. Anecdotal evidence and sentiment indicators suggest that within the last week, France has turned into Europe’s least favoured equity market, now trading close to technically "oversold" levels. There are also implications for the broader European market: One of the positive cases for European equities was linked to potential inflows from foreign investors, who may be put off by recent events. Political uncertainty has weighed on the euro, too, but the impact has so far been relatively modest. 

The upcoming elections in France have significant implications for various asset classes. Uncertainty is expected to remain elevated as fears of a potential debt crisis and political destabilisation in the European Union persist. 

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