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In May, credit rating agency S&P Global downgraded the creditworthiness of French government bonds, essentially telling the country’s politicians: just do it.
“Political fragmentation contributes to uncertainty about the government’s ability to continue implementing policies that increase economic growth potential and address fiscal imbalances,” the report said in a note accompanying the decision to downgrade the country’s rating one notch to AA-, still a sign of quality but a downgrade nonetheless.
That was on May 31, before the European parliamentary elections set off a chain reaction of national votes that ended Sunday with a hung parliament. The far right did well, but not well enough to counter the surge in support for a hodgepodge of centrists, communists and greens who banded together to keep Marine Le Pen’s Rassemblement National out of the prime minister’s office.
What follows is a prolonged period of bickering, posturing and loaded claims by rival politicians to provide the one true voice of France. In other words, as far as markets are concerned: plus ça change.
At a briefing on Monday, Benjamin Melman, global chief investment officer at Edmond de Rothschild Asset Management in Paris, said on the plus side that the messy vote means there will be “no Liz Truss moment” of bond-market fireworks fueled by a radical shift in fiscal policy. But, he added, “I don’t see a solution to the medium- to long-term problems that France faces.” The country should brace itself for one or two more downgrades from ratings agencies, he added, and more parliamentary elections in a year or so.
Politically, everything has changed in France. Economically, the things that investors really care about, not so much. That is why so far (and it is good to remember that this is just the beginning, a lot can still go right or wrong) we have only seen fleeting declines, in the euro, in French stocks and in the country’s government bonds.
In fact, stasis, bickering and posturing, while arguably bad for democracy, are in many ways exactly what investors want to see continue. They were nervous about the possibility of a far-right government. While RN had promised to play nice with the markets, the prospect of years of fighting with the EU over budgets risked turning France into the new Italy, historically vulnerable to bond market swings. At worst, RN could rekindle its love of Frexit.
But they were also nervous about the prospect of the far left also emerging victorious. They still are. As Mark Haefele, Chief Investment Officer of UBS Global Wealth Management, noted on Monday, one option for President Emmanuel Macron is to now appoint a prime minister from the party that won the most seats, in this case the far-left Nouveau Front Populaire.
“An NFP government would likely seek to undo recent pension and unemployment reforms, raise the minimum wage, and not engage in fiscal consolidation, in our view,” Haefele and his team wrote Monday. “We believe the NFP program, if implemented as proposed, could lead to a significant deterioration of the already high budget deficit.” That’s not a great outcome for the French government’s borrowing costs, which is not a great outcome for French business. Which is why, for many, an ineffective hung parliament is the best of a range of unpalatable options.
All this drama will hang over not just France, but all of Europe for some time to come. “It is possible that asset allocations to [French equities] “The value of our investments will be permanently reduced,” said Frederic Leroux, member of the strategic investment committee of French investment house Carmignac.
What’s more, it’s all a messy excuse for global investors outside Europe to avoid the continent altogether. “The problem is the perception of Europe outside Europe,” said Nicolas Faller, co-chief executive of asset management at Swiss asset manager UBP. “Every year we have a good reason not to invest in Europe,” he said. Something always comes along to dull clients’ interest in Asia, for example. Why bother trying to understand the complexities of Europe when the US moves fast, breaks things and delivers strong market returns?
Overall, this result is a surprise. Opinion polls had been pointing to a far-right majority that has not materialized. That’s a useful reminder not to rely too much on opinion polls ahead of the US elections looming looming later this year. But as Rabobank analysts said in a note: “This is more of a surprise in style than in substance… The outcome is the same, in that we are now likely to enter a period of policy paralysis.” Plus ça change indeed.