Higher debts and looming euro crisis as consequences?

The announcement of early parliamentary elections in France by President Emmanuel Macron has sent shockwaves through the stock and bond markets in recent weeks. And growing concerns about French public finances have led to a loss of confidence among investors.

This is reflected in the increased yield difference (“spread”) between government bonds from France and Germany. If a debtor is considered less trustworthy, it has to pay higher interest on the capital markets. On Friday, ten-year French government bonds yielded 3.29 percent, 0.8 percentage points more than German government bonds. This is the highest yield difference since the presidential elections in 2017.

French stocks lag behind

The decision to bring forward the parliamentary elections has also left its mark on the stock market: the French leading index, the CAC 40, is down 0.9 percent this year, lagging significantly behind the leading indices of other European countries. The stock index of the 50 largest listed companies in the euro zone, the Euro Stoxx 50, is up 8.2 percent this year.

The parliamentary elections on June 30 and July 7 could now be won by the Rassemblement national (RN) of right-wing populist Marine Le Pen or the left-wing alliance Nouveau Front populaire (“New Popular Front”). The prospects for the center around President Macron do not look good at the moment.

Investors fear that France’s fiscal situation could deteriorate significantly if the extreme right or the extreme left wins the election. Both sides stand for even higher government spending and little financial discipline. What could happen if the RN or the New Popular Front win the election? These are the most important questions and answers about the early parliamentary elections in France.

1. Could an election victory of an extreme party trigger a euro debt crisis?

Daniel Hartmann, chief economist at asset manager Bantleon, believes that an immediate escalation and repetition of the euro debt crisis as in the period from 2010 onwards is rather unlikely. The RN has abandoned extreme demands such as France’s exit from the euro (“Frexit”) and has recently shown itself to be more willing to compromise with Brussels. However, there could be a gradual deterioration in France’s creditworthiness. This would justify higher risk premiums for French government bonds.

According to Matthias Hoppe, portfolio manager at fund provider Franklin Templeton, investors’ concerns include political instability in France, fiscal indiscipline and potentially anti-business policies with higher taxes and government interventions. However, he believes a repeat of the euro crisis is unlikely. The political framework of the euro zone has improved significantly since then. The European Central Bank (ECB) has more instruments at its disposal to stabilize the money markets.

Economists at Helaba Bank are relatively optimistic. They believe that investors’ scepticism could subside somewhat in the coming weeks once the election results are known. In their view, an even higher interest rate premium on French government bonds compared to German ones, which would ultimately trigger a deeper crisis, would only be likely if the election results were to result in a sharp increase in national debt.

2. Is there a risk of a similar scenario to that in Great Britain under then Prime Minister Liz Truss in 2022?

The financial markets are debating whether an extreme party’s election victory in France could lead to a scenario similar to that which followed the election of Liz Truss as British Prime Minister in 2022. At the time, Truss and her Chancellor of the Exchequer Kwasi Kwarteng presented a program of tax cuts and energy aid that was interpreted on the capital markets as fiscally reckless and drove up yields on British government bonds. Ultimately, the Bank of England had to rush to the rescue and Truss had to resign after only six weeks in office.

Laurent Denize, co-head of investments at the Oddo BHF financial institution, stressed that the RN’s original program seemed unbalanced. However, in recent weeks, representatives of this party have begun to de-prioritize some costly measures. It therefore seems that the RN is well aware of the financing constraints imposed by the bond market – especially since French bond issues have historically been subscribed to around half by foreign investors. If confidence were to continue to fall, there is a risk that they would withdraw.

“It is to be hoped that the RN has learned from Liz Truss’s short term in office and will instead draw on the experience of Georgia Meloni’s government in Italy, which managed to win over the markets,” says Hoppe. He also points to the upcoming presidential elections in France in 2027. In fact, these could prevent RN representatives from confronting the financial markets and Brussels in order not to jeopardize their chances.

3. What opportunities and risks do French stocks and bonds offer?

The poorer performance of the CAC 40 compared to other leading European stock market indices has largely occurred in the past two weeks.

Hoppe points out that the MSCI EMU stock index – which contains shares from the Eurozone, including France – and the MSCI France index were roughly on par until the announcement of the new elections. However, with a price-earnings ratio of 15, the market is not exactly expensive.

Denize sees certain opportunities. The stock prices of some French companies that operate primarily internationally and have no financing problems may have been overly burdened, he says. This applies, for example, to the shares of companies that operate in the luxury goods sector.

Following the announcement of the new elections, shares of French utilities, telecoms and banks suffered particularly. Hartmann attributes this to the prospect of weak economic development and possible regulatory interventions by a new political leadership.

Economists at J. Safra Sarasin Bank, however, remain cautious about investing in France. There are high risks and only a small chance of significant fiscal consolidation in the country – regardless of who ultimately wins the elections.