France elections: 4 scenarios according to the markets

The political elections in France, which will be held on June 30, are now a "case" also for the financial markets.

Macron’s announcement of the early dissolution of the National Assembly in the aftermath of the vote for the European Parliament was a real earthquake for the European stock exchanges, the euro and the French bonds. The nation’s stock index plummeted, the community currency slipped against the dollar and the cost of French debt soared.

The very likely possibility that the far-right party Rassemblement National forms the new government with the very young Bardella as prime minister has put both investors and economists on high alert. Macron hopes to focus precisely on the fear of extremism to convince voters to trust him again, thus avoiding the escalation of both Marine Le Pen’s party and the left-wing alliance.

In the analysts’ sights are above all the economic plans of the two most extreme camps, which are accused of being impracticable as they would increase public spending and unprecedented debt. France finds itself in a complex situation from the point of view of public finances, with the EU infringement procedure for excessive deficit also affecting its accounts.

In this context, the French elections remain a big unknown for investors. Analysts have identified 4 possible scenarios on the outcome of the vote. All will have impacts on financial assets.

1. Le Pen wins, but without a majority

The most likely outcome, based on current polls, is that Le Pen’s party and its allies will become the largest group in Parliament, but will not achieve an absolute majority. In this scenario, Jordan Bardella should keep his promise and refuse to be prime minister in a minority government.

This will cause a deadlock in the Lower House, probably forcing Macron to choose a provisional prime minister who is very vulnerable in the event of a vote of no confidence, especially on the budget.

fiscal policy could be slightly more expansionary with lawmakers expected to resist Macron’s promised spending cuts. In essence, according to analysts, Macron’s economic strategy should be shelved.

The short-term implications for the economy may be limited, but without further business-friendly measures or changes to labor laws and vocational training, France’s long-term growth potential is unlikely to improve.

“We see a significant risk of political stalemate and uncertainty, which could lead to continued market volatility”, according to Theophile Legrand, strategist at Natixis.

These are the implications on assets in such a scenario:

• Bonds: Investors continue to demand a higher premium to hold French bonds, cementing a new hierarchy in Europe, where French debt is perceived as risky as that of economies including Portugal;

• Strategists see the spread between French and German 10-year yields narrowing slightly from around 80 basis points to around 70 basis points, but say it is unlikely to return to the 50 basis points seen before Macron called early voting. According to Ministry of Finance estimates, this loan price increase could cost the French government at least another 4 billion euros annually after five years;

• Stocks: Stocks sensitive to higher yields are likely to suffer, including French banks Vinci SA and Eiffage SA. Other domestic stocks less sensitive to sovereign risk, such as Carrefour SA, could see a relief rally

2. Le Pen wins and forms government

If Rassemblement National and its allies win the votes required to form a government, France will face a situation known as "cohabitation," where the president oversees defense and foreign policy, while the far right controls internal and economic affairs. This is a forced result because Macron and Le Pen are bitter enemies.

Despite all the tensions, however, the economic and fiscal policy implications may be more favorable than the initial investor reaction to Macron’s early vote suggested, according to an analysis in Bloomberg.

The far-right party has reduced some of its most expensive promises and must avoid a financial crisis if it wants to build credibility for Le Pen’s likely presidential run in 2027. This means cooperating with the EU to contain deficits, a no mean feat for a group that has often criticized Brussels and once supported leaving the euro.

Even in this scenario, Bardella will still have to implement some expensive policies such as cutting taxes on energy sales – a cost estimated at 12 billion euros – to please the working-class base that supports Le Pen’s party. Unspecified savings from fighting tax evasion and cutting spending on immigrants are expected to finance this measure.

These are the possible implications on the markets in this scenario:

• Bonds: Barclays estimates that the yield premium over Germany will remain high at around 80 basis points. But with more fiscal expansion, it could rise above 100 basis points, a level last seen in the depths of the Eurozone debt crisis;

• Stocks: Once again this outcome depends on how far the party pushes France’s narrow fiscal space. If French credit swaps were to deteriorate, the sectors most at risk would be banks, construction, utilities, and defense, while domestic stocks would likely underperform international ones.

3. Victory for the left-wing alliance

While attention has focused on the far right, the left-wing New Popular Front, which ranges from pro-market Social Democrats to more radical positions, has gained momentum in opinion polls.

If the NPF gains a role in the decision-making process and its more extreme members maintain the upper hand, this is likely to be the most negative outcome for markets.

In this scenario, several analysts say, the alliance will push to reverse seven years of pro-business reforms, while adding vast new spending plans and large minimum wage increases. A clash with Brussels would be inevitable and potentially disastrous.

“Their agenda represents very large fiscal expansion and a confrontational approach to the EU,” said Jason Davis, global rates portfolio manager at JP Morgan Asset Management. “The market will fear both the fiscal consequences in France and the consequences for European cohesion”.

In such a political situation, markets could react in this way:

• Bonds: This is the worst-case scenario and one that would likely send the spread above 100 basis points, according to Davis.

• Stocks: This is a high-risk outcome currently undervalued by stock markets, which are focused on the potential victory of the Rassemblement National. A previous far-left government in the 1980s triggered capital flight. Some strategists see a 20% drop for the CAC 40 index in the immediate aftermath.

4. Macron’s party wins the elections

In the scenario considered the most unlikely, Macron’s party and its allies downplay their losses and remain the largest group, allowing them to maintain the limited control they have had over the legislature since losing their absolute majority in the elections of 2022.

In theory, the president can appoint a government to resume his reform agenda and pursue fiscal consolidation based on deeper spending cuts.

Even if that were to happen, Macron would likely still have to demonstrate that he has listened to calls from most parties to do more for household wallets and less for businesses, limiting his room for maneuvering on public finances.

“In the long term, French spreads should stabilize at structurally wider levels than before the early elections”, said JP Morgan Asset Management’s Davis. “You would be in a better position buying bonds with better credit histories, such as those of Spain, for long-term trading.”

In this scenario, markets can react like this:

• Bonds: Some strategists say this outcome could allow bond yield spreads to return to the 50 basis point level seen earlier this month;

• Stocks: Stocks would likely rally quickly and return to levels seen before the dissolution of parliament, with domestic stocks in the driving seat.

It should be highlighted that the French elections involve a double round, on 30 June and then on 7 July. The outcome of the vote is highly awaited for European political, economic, and financial balances.

Original article published on Money.it Italy 2024-06-24 13:04:34. Original title: Elezioni in Francia, i 4 scenari osservati dai mercati