European Parliament and French elections: Investor update

The European Parliament elections led to significant gains for centre-right and right-wing parties, prompting French President Emmanuel Macron to call a snap election. Our investment experts assess the near-term political outlook, as well as potential longer-term scenarios, and analyse the impact on fixed income and equity markets.

Gilles Moëc, AXA Group Chief Economist

The call for snap elections has introduced a high degree of uncertainty regarding France’s future macroeconomic policies, particularly in relation to fiscal policy. This uncertainty has had a notable impact on financial markets, with a significant increase in the spread on the 10-year yields between France and Germany. This increase, from roughly 75 to 80 basis points (bp), represents an uptick of approximately 30bp compared to the pre-election situation. As a result, France is now trading in close proximity to Spain, a departure from the usual trading patterns.

Fortunately, at the same time global long-term interest rates have declined thanks to positive news on US inflation. Despite the spread between French and German yields increasing, absolute yields have not tightened significantly, maintaining a level of 3.1 to 3.2% on the 10-year bond, which has not exerted a major impact on the French or European economy from a macroeconomic transmission standpoint.

However, the banking sector experienced significant turbulence, with the largest French banks witnessing a reduction of 10% to 15% in their equity value in the week following the announcement of the election. This correction, while partly attributed to a correction of previous strong performance, raised concerns about its potential impact on lending to the private sector. Estimates by the Bank of France suggest such a decline in equity value could lead to a reduction in lending to the corporate and household sectors by approximately €20bn, which we see as signifying a potentially significant macroeconomic impact.

Looking ahead to the upcoming elections, the polling data indicates a lack of clear majority for any of the competing political blocks, including the far right, centrist, and left alliance. The absence of a clear majority points towards the likelihood of a hung parliament, a scenario that presents challenges in governance given the strongly majoritarian presidential system. Other potential outcomes include the formation of a caretaker government, a far-right majority, or a left alliance victory, each carrying its own implications for fiscal policy and market stability.

The uncertainty surrounding the election outcomes and the subsequent governance structure has raised concerns about the potential impact on fiscal stability and the macroeconomic trajectory of France while the country, irrespective of the election outcome, needs to undertake significant corrective fiscal measures. The complexity of the situation, especially in the absence of a clear majority, presents challenges in terms of compliance with European rules. This has implications for the stability of the European monetary union and raises questions about the role of the European Central Bank (ECB) in dealing with elevated spreads in the bond market: the recourse to ECB purchases of government bonds entails compliance with the European fiscal framework. Both the far right and the left alliance explicitly reject this.

The prevailing uncertainty and its potential impact on markets and fiscal stability underscore the need for pragmatic approaches and creative solutions. Despite the uncertainties, institutions and fiscal processes are expected to continue, but the overall situation is likely to remain uncertain for an extended period.

Chris Iggo, CIO, Core Investments

The spread between French and German government bonds stabilised at 75bp to 80bp following the election announcement. While spreads on French corporate bonds have widened by around 20bp to 25bp, investors have generally maintained a positive view on fixed income markets, largely influenced by expectations of further interest rate cuts by the ECB.

The uncertainty stemming from the election outcome may not immediately revert the spread to pre-election levels, and the comparison with Spain's bond levels suggests a more appropriate trading position for France. The short-term market outlook will be shaped by election scenarios, economic data, and central bank policies. Despite the market movements, there are no major alarms in the credit markets, with strong fundamentals supporting issuers, particularly in the financial, utilities, and telecommunications sectors. The potential spread widening in credit markets could present a buying opportunity if driven by sentiment rather than fundamental deterioration. Additionally, the French equity market has underperformed compared to other major indices since the election announcement.

Alessandro Tentori, Europe CIO, Core Investments

The current environment immediately brings to mind the political landscape of Italy in 2018. During that time, Italy faced a split parliament with the Five Star Movement as the largest faction, and a centre-right alliance as the largest group. This led to the formation of a hybrid government, the Conte 1 government, uniting the Five Star Movement and Matteo Salvini's Lega. The government faced challenges, including Salvini's confrontations with European institutions over immigration policies and concerns about fiscal stability due to the introduction of the universal income by the Five Star Movement, which incurred significant costs.

The contrast with the current situation under Giorgia Meloni’s government is notable. Italy now has access to €230bn from the Next GenerationEU fund, which all parties, especially Meloni's Fratelli d'Italia, are eager to manage and invest. Unlike in 2018, there is a strong incentive for parties to align with the European agenda to access and utilise these funds. This difference underscores the significant impact of uncertainty on the political and economic environment.

Whether the Meloni government now has more flexibility to pursue its policy agenda, and whether it will deviate from the current stance, will partly depend on the composition of the European Commission and Italy's ability to place sub-commissioners in key positions, which would be seen as a victory for the current government. In terms of domestic politics, I believe that everything is set to continue in the direction established in previous years. This confirms that the country is content with this government, despite having to backtrack on certain issues not directly related to European Union (EU) institutions, particularly in foreign and immigration policies.

Gilles Guibout, Head of Equity Europe

The market reaction to the announcement of France’s snap election was arguably a natural response, with investors initially de-risking in anticipation of a potentially negative outcome. This led to the selling of companies heavily exposed to France, particularly those reliant on the domestic market, such as banks and regulatory names like Vinci and Engie in the energy sector. However, the severity of this reaction may have been excessive, as different outcomes from the election could have varied impacts, particularly with regards to taxes and labour costs under different political leadership.

While some regulated names may have been overly affected, for example as both parties want to nationalise highways, there are expectations that certain companies, like Vinci and Lafarge, are unlikely to be nationalised owing to costly indemnities that would be due, and could even deploy capital outside of France. The most understandable market concern is seen in the banking sector, which is highly sensitive to economic conditions and interest rates. Until there is more clarity on the government's stance on deficit containment, market volatility is expected to persist. In response to this, we have slightly reduced our exposure to banks, while selectively considering companies affected by the market's indiscriminate drop.

The recent market reaction has halted the inflows that were starting to come into the European market, even leading to some redemptions. However, European companies remain attractive due to their global exposure, with around 60% of their revenue coming from global markets, and approximately 25% exposure to the US market. This global presence has made them competitive on a global scale. While there are differences between companies, European firms generally trade at a discount compared to others of similar quality, making them a potentially appealing investment opportunity.