Messy French politics point to broader malaise for investors

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Back in May, rating agency S&P Global downgraded French government bonds and in effect told the country’s politicians: get your act together.

“Political fragmentation adds to uncertainty regarding the government’s ability to continue implementing policies that increase economic growth potential and address budgetary imbalances,” it said in a note accompanying its decision to cut back the country’s rating by one notch to AA-, still a mark of quality but a downgrade nonetheless.

That was on May 31, before European parliamentary elections set off a chain reaction of national votes that ended on Sunday with a hung parliament. The far right did well, but not well enough to face down a surge in support for a hodgepodge of centrists, communists and greens who worked together and rallied behind the cause of keeping Marine Le Pen’s Rassemblement National away from the prime minister’s desk.

What comes next will be a prolonged period of squabbling, posturing and fraught claims by rival politicians to offer the one true voice of France. In other words, as far as markets are concerned: plus ça change.

In a briefing on Monday, Benjamin Melman, global chief Investment officer at Edmond de Rothschild Asset Management in Paris, said on the plus side, the mishmash vote outcome means “there’s not going to be a Liz Truss moment” of bond-market fireworks sparked by a strident shift in fiscal policy. But, he added, “I don’t see a solution to the medium- to long-term problems France is facing”. The country should brace itself for one or two more downgrades from rating agencies, he added, and for yet more parliamentary elections in a year or so.

Politically, everything has changed in France. Economically, the stuff that investors really care about, not so much. That is why so far (and it’s worth remembering these are early days, much can still go right or wrong from here) we have seen only fleeting dips, in the euro, in French stocks and in the country’s government bonds.

In fact, stasis, squabbling and posturing, while arguably bad for democracy, are in many ways exactly what investors want to see continuing. They had been nervous about the possibility of a far-right government. Even though RN had promised to play nicely with markets, the prospect of the party spending years fighting with the EU over budgets posed the risk that France could become the new Italy, which was historically vulnerable to bond market wobbles. In a worst-case scenario, the RN could rekindle its fondness for Frexit.

But they had also been nervous about the prospect of the far left emerging victorious too. In fact, they still are. As UBS Global Wealth Management’s chief investment officer Mark Haefele pointed out on Monday, one option for President Emmanuel Macron now is to appoint a prime minister from the party that gained the most seats, in this case the hard-left Nouveau Front Populaire. 

“An NFP government would likely try to undo the recent pensions and unemployment reforms, increase the minimum wage, and not engage in fiscal consolidation, in our view,” Haefele and his team wrote on Monday. “We believe the NFP’s programme, if implemented as proposed, may lead to a significant deterioration in the already high budget deficit.” That is not a great outcome for French government borrowing costs, which is not a great result for corporate France. In turn, that is why for many, an ineffectual hung parliament is the best of a series of unpalatable options.

All this drama will hang over not just France but all of Europe for some time to come. “It’s possible that asset allocations to [French equities] will be permanently reduced,” said Frederic Leroux, a member of the strategic investment committee at French investment house Carmignac.

In addition, it all provides another messy reason for global investors outside of Europe to just give the continent a wide berth. “The problem is the perception outside Europe about Europe,” said Nicolas Faller, the co-chief executive for asset management at Swiss wealth manager UBP. “Every single year we have a good reason not to invest in to Europe,” he said. Something always crops up to dull the interest of clients in Asia, for example. Why bother putting the effort in to understanding Europe’s complexities when the US moves fast, breaks things and delivers strong market returns?

Overall, this result is a surprise. Opinion polls had pointed to a far-right majority that has failed to materialise. That is a useful reminder not to rely too heavily on opinion polls ahead of the US elections looming ominously into view later this year. But as Rabobank analysts said in a note: “This is something of a surprise in style more than substance . . . The outcome is the same, in that we are now likely looking at a period of policy paralysis.” Plus ça change indeed.