Uddrag fra Julius Bär
Key take-aways
- With no party securing a majority in France, the likelihood of the radical policies that markets had feared has diminished.
- French assets and the EUR may remain vulnerable during the uncertain period of government formation and beyond, but broader damage should be limited.
- In the UK markets have reacted indifferently to a shift in government, as the potential for significant raises in fiscal spending is restricted by limited fiscal headroom.
French elections: Uncertainty remains after a coalition forms
The second round of parliamentary elections in France brought a surprising reshuffle with a left-wing alliance winning the most seats. However, it confirmed a hung parliament with three major blocs and no clear majority. Uncertainty remains over the coalition that will form a new executive and whether the results will clearly show who will govern. With neither the left- nor right-wing alliances winning an absolute majority, fears of a more spending-driven fiscal policy remain limited.
This month’s key points for investors
What are this month’s macroeconomic findings and key dates that investors must consider?
French elections: Some pressure on the EUR and higher spreads
This unexpected twist in the elections does not materially change the outlook for the Euro (EUR) and French assets. Naturally, political instability in France and a shift of power to the more spending-oriented left would lead to some pressure on the EUR and higher spreads on French government bonds, as well as on financially weaker countries such as Italy. However, with no party securing a majority, the likelihood of the radical policies that markets had feared has diminished.
As a result, initial market reactions have been very limited. The EUR has already reversed its early dip, French yields are flat, and equities were even slightly up at the time of writing. The reduced threat of additional fiscal spending, already apparent after the first round, has also already led to a restrengthening of the EUR.
What risks remain?
Some risks remain if a possible leftleaning government chooses to challenge the restrictions of the Stability and Growth Pact and the new fiscal framework applicable to the upcoming 2025 budget. The bond market will not like the shift towards the left, which strongly favours further spending, and the less clear path to a new government.
However, we believe that major damage for the broader European bond market will be contained, given an attentive European Central Bank that is equipped with sufficient tools and is ready to intervene if necessary. Meanwhile, equities with French exposure dropped by an average of 10% after the election announcement, partially recovering after the first round but still carrying a significant risk premium.
Political instability in France and a shift of power left would lead to pressure on the EUR and higher spreads on French government bonds, as well as on financially weaker countries such as Italy.
UK elections: Markets are ignoring the Labour landslide
The Labour Party cruised to a spectacular absolute majority at last Thursday’s elections, winning 412 seats (326 seats needed for an absolute majority). This result is no surprise and reflects the polls in the run-up to the election. The crushing defeat of the ruling Conservative Party of Prime Minister Rishi Sunak was broadly expected.
In the past few years, the Tories have blown their political capital with a dubious track record. The hard shape of Brexit, which created a border in the Irish sea to Northern Ireland, the Partygate scandal during the Covid-19 lockdown, the cost-of-living crisis that followed the pandemic, the irresponsible fiscal policy of the Liz Truss government that made her term in office the shortest in history, and finally the betting scandal during the campaign.
UK elections: Limited room to manoeuvre
The impact of this political shift on markets has remained marginal, as the potential for significant changes in fiscal policy to more spending is restricted by limited fiscal headroom. Furthermore, Labour has limited political capital, capturing only 33.8% of votes despite the landslide victory, limiting its room to manoeuvre. Finally, things can hardly become any worse and markets have likely embraced the promise of more political stability going forward. Accordingly, the elections did not increase volatility.
The Great British Pound (GBP) remains broadly unaffected by politics, with the monetary policy outlook and the cyclical backdrop remaining the more important drivers. With the Bank of England easing their monetary policy later than European peers, and the economy in recovery mode, the GBP remains well supported at current levels.
With the Bank of England easing their monetary policy later than its European peers and the economy in recovery mode, the GBP remains well supported at current levels.
What does this mean for investors?
Considering the big changes, the markets have reacted indifferently to the shift in governments for both France and the UK. While French assets and the EUR may remain vulnerable during the uncertain period of government formation and beyond, the broader damage should be limited as none of the extreme parties have won an absolute majority. In the UK, the GBP remains supported by a patient Bank of England (BoE) and the UK’s cyclical recovery, which we see continuing until the BoE starts to cut its rates in August or, more likely in our view, in September.
