(Bloomberg) — French bonds and stock futures retreated on worries that the surprise victory for the leftist alliance will lead to policies that pressure the country’s already-strained finances.
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Contracts on the CAC 40 Index slid 0.7%. French bonds fell as trading kicked off, widening the 10-year yield spread over German peers by four basis points. The euro weakened 0.2%, snapping a seven-day winning streak.
The left’s success has shone the spotlight on its campaign for a sharp increase in government spending. That would exacerbate fears over France’s balance sheet and put the nation on a collision course with the European Union, which is already taking action to curb the budget deficit.
Still, the left alliance lacks an absolute majority — limiting how much it can do — and some strategists suggested a hung parliament would be a positive outcome for investors.
While money managers have spent the last week or so fretting over a Le Pen-dominated government, the left’s success is still a concern for investors because it amounts to a fresh dose of uncertainty in the euro-area’s second-largest economy and foreshadows more political wrangling ahead.
The gap between 10-year French and German yields, a measure of credit risk, sits at around 70 basis points, below levels seen at the height of the market rout last month.
Investors May Warm to French Result After Nervy Initial Reaction
“French politics confounds yet again,” said Geoffrey Yu, senior strategist at Bank of New York Mellon. “Based on the results, risks of expansionary fiscal policy remain, and perhaps on the margins have picked up.”
The New Popular Front — which includes the Socialists and far-left France Unbowed — won 178 seats in the National Assembly, according to data compiled by the Interior Ministry. Marine Le Pen’s National Rally, which pollsters last week had seen winning the election, came third with 143, while President Emmanuel Macron’s centrist alliance notched up 156.
French markets plunged into a tailspin in June, wiping out billions of euros from stocks and bonds as Macron’s snap poll prompted concern that the far-right would take power. But over the past week, traders pared a chunk of those losses as opinion polls indicated that the National Rally would fall short of an outright majority. France’s CAC 40 Index last week erased about half of the losses it endured in the aftermath of Macron’s announcement.
The outcome is very different: Macron’s centrist party — favored by investors — came in second place, despite a poor showing in the first round of voting. That could leave the president in a position to cobble together a centrist coalition.
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“Already the French far-left leader is saying he will implement his entire program and that he is unwilling to to enter any deals with Macron. That tone of defiance will hardly sit well with French bond investors.”
— Ven Ram, cross-asset strategist
An absolute majority for the left was identified by investors as the scenario they were most concerned about in the days ahead of the first round of votes. But that possibility was discounted after Le Pen’s National Rally convincingly won the first round. Among its pledges, the left coalition wants to reverse seven years of pro-business reform and hike the minimum wage.
The Institut Montaigne estimates that the New Popular Front’s campaign pledges would require nearly €179 billion ($194 billion) in extra funds per year.
France is already grappling with a budget deficit that at 5.5% far exceeds the 3% of economic output allowed under European Union rules. The International Monetary Fund predicts that — without further measures — debt would rise to 112% of economic output in 2024, and increase by about 1.5 percentage points a year over the medium-term.
S&P Global Ratings downgraded France in late May, highlighting the French government’s missed goals in plans to restrain the budget deficit after huge spending during the Covid pandemic and energy crisis.
Vincent Juvyns, global market strategist at J.P. Morgan Asset Management, said tensions were likely with reforms spearheaded by Macron now in doubt, potentially hurting the value of French bonds versus their peers.
“Markets may demand a higher spread as long as the new government hasn’t clarified its fiscal position,” he said. “The European Commission and rating agencies are expecting 20 to 30 billions of cuts but the government will actually have to deal with a party which want to increase spending by 120 billion.”
–With assistance from Vassilis Karamanis.
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