The results of the second round of president Emmanuel Macron’s snap French legislative elections should see French sovereign credit diverging further from that of Germany, although there may be no material jump higher in French borrowing, according to asset managers.
Yesterday’s election results suggest a hung parliament, albeit with the far-right Rassemblement National (RN) party being pushed into a surprise third place after centrist and leftish parties coordinated candidates to avoid splitting the anti-RN vote.
Instead, a newly-formed left-wing alliance, whose pledges include scrapping Macron’s reform of the pension system, came first, with Macron’s centrist coalition outperforming post-first round expectations by squeezing into second place.
“President Macron took a huge gamble by calling snap polls after a poor showing of his party in European elections. It didn’t pay off,” said Van Luu, global head of solutions strategy for fixed income and currencies at Russell Investments.
“European financial markets are still sailing in choppy waters. Sunday’s result is not the catalyst for a sustained rally in French stocks and bonds, despite the latter looking heavily oversold.”
After rising from around 50bps before Macron called the election to more than 80bps, the spread of 10-year French government bonds over Bunds has more recently been hovering around 70bps-75bps.
At Carmignac, Frederic Leroux, a member of the strategic investment committee, said the spread is likely to rise gradually, increasing the cost of French debt and contributing to the weakening of the French economy.
Commenting on the exit polls last night, Peter Goves, head of developed market debt sovereign research at MFS Investment Management, said a “rainbow coalition” or a “caretaker government” are feasible, and although “definitely not the most politically palatable outcome, but equally, not the most market unfriendly outcome”.
“We stick with our 70-90bps range for the near term for OAT-Bund spreads,” he said. “OAT-Bund spreads may find some near-term comfort, but we are still looking at a potentially politically unstable medium outcome environment.”
Budget bill deadline
At Nomura, senior European economist Andrzej Szczepaniak said OAT-Bund spreads were likely to narrow again “once a centrist technocratic candidate is installed as prime minister, and political uncertainty subsides”.
Carmignac’s Leroux said the most likely scenario is that of a deadlock preventing any major legislative initiative.
“France will then manage its day-to-day affairs, until the next dissolution (in over a year’s time) or the resignation of the president of the republic, against a backdrop of further deterioration in public accounts,” he said.
Gilles Moëc, group chief economist at AXA Investment Managers, said that although investors now knew that the most radical policy proposals in France would not be implemented, “it remains unclear how France will be governed”.
The most extreme factions taken together will not have the numbers to pass a motion of no confidence to stop a “central coalition” from governing, he said, adding that although this was positive for political stability, forging such a coalition was still likely to prove difficult.
A minority or technical government was another option to break the deadlock, but this would likely only focus on “minimalist” policymaking.
Moëc said the asset manager maintained its view that elaborating the budget bill – which needs to be transmitted to parliament in early October at the latest – is the real deadline for a political solution to emerge.
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