Market Update 1st July 2024

French Twist

In the wake of the Brexit referendum in 2016 Nigel Farage said “We may be close to Nexit. We could be quite close to Dexit”. He is referring here to the Netherlands and Denmark following the UK out of the EU. At other times he has claimed Sweden, Austria and Italy will be leaving as well. Italy has a far-right government, as do Hungary and Poland.

2016 is eight years ago now and say what you like about Nigel, but based on this his ability to predict the future is limited.

France had the first round of parliamentary elections yesterday. Marine Le Pen’s far right Rassemblement National (RN – the former Front National renamed in 2018) came out on top according to exit polls, although they appear to have done slightly less well than expected. Early indications show them with about 31.5% of the vote, with President Macron’s Renew party on just 15%. Late last week RN were expected to win around 33-35% of the vote.

It is still not completely clear how things will go in the second round next Sunday. President Macron’s party is down in third place and might or might not be able to form alliances. Political polling company IPSOS is predicting 230-280 seats for RN in the second round. 289 seats is the minimum for an outright majority in the French National Assembly.

How is this impacting markets? French and German government bonds yields usually trade close to each other. The market perceives them as more or less equally risky. The surprise election in France has caused French bond spreads to widen significantly, though not enough to keep Liz Truss awake at night. French spreads have gone to about 82bps over German bunds. Liz really rolled her sleeves up and got us to about 240bps.

France has been here before. In the 2017 Presidential elections, the first round of voting was tight between four candidates, with Marine Le Pen coming a close second to Macron. He ended up winning easily in the second round, but French bond spreads over German bonds spiked in the meantime.

One policy Marine Le Pen campaigned on in 2017 was a French referendum to leave the EU, following the UK in 2016, but even the rebranded National Front stopped talking about this some time ago. With EU referendums and / or leaving the euro off the table these days, France’s problems are likely to stay in France.

The French equity market has been weak since the election announcement, but just 14.5% of the CAC 40 revenue comes from France. 21% is from the US, 27.6% from Emerging and Frontier markets. It’s a diverse market.  The index fell about 8% in the weeks following the news, but has bounced slightly since and is up a couple of percent this morning.

One point of difference this time around is the relative weakness of France’s government finances.

Before the elections were called, S&P downgraded France to AA- from AA on 31^st May on the back of its 2023 budget deficit reaching 5.5% of GDP. France’s budget deficit has been widening, while for example Italy’s is shrinking.  France runs a trade deficit, while Italy runs a surplus. The one advantage France has is a lower interest rate vs the high coupon bonds Italy was forced to issue during the Eurozone debt crisis, but this will disappear over time as those bonds mature.

France has the third highest government debt to GDP ratio in the Eurozone (109%), behind Greece and Italy, but now higher than Ireland, Portugal and Spain, all casualties of the post-GFC Eurozone debt crisis. France looks much more like Southern Europe than Germany these days. The market is worried about what RN might do if they find themselves in power.

Alternatively, RN having gained power might want to stay there. They will know what happened in the UK. They also have a potential template to the South, in Italy where Giorgia Meloni has led a far-right government since late 2022. Italian bond spreads also widened significantly – by about 100bps, reaching around 250bps over German bunds. However they have since fallen and are now below their long term average.

Giorgia Meloni was elected on 21^st October 2022. Since then, the Italian market and economy have done relatively well. The Italian equity market is up 76% in a little under two years. That’s more than the S&P 500 (50%) and a lot more than Germany (43%), France (31%) and the UK (25%) over the same period.

She has brought them into line with EU fiscal guidelines for example, partly in order to access EU post-covid recovery funds. Talk of Italy leaving the EU is also long gone, and much of the more radical campaign talk has also disappeared since she came to power.

If only we could work out what has happened over the last eight years to make the rest of Europe change their mind about leaving the EU.

Robert Fullerton – Senior Research Analyst

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