The European financial markets are on edge as the French parliamentary elections draw near, with the first round set for this Sunday and the final round scheduled for July 7th. The stakes are high, with potential implications for the fiscal stability of France and the broader European sovereign debt market.
Potential Outcomes and Market Reactions
Recent polling data from Harris Interactive, Ifop, Elabe, Ipsos, Odoxa, OpinionWay, and Cluster17 indicate a tight race. Marine Le Pen's National Rally (RN) is leading with a median 35.4% of preferences, followed by the far-left New Popular Front (NFP) at 28.1%, and President Emmanuel Macron's Renaissance at 20.8%. These figures suggest a potential second-round contest between far-right and far-left coalitions, potentially sidelining Macron's centrist parties.
Sonia Renoult, a rates strategist at ABN AMRO, has raised concerns about the potential fiscal instability that could arise from the elections. She noted, "France's government finances were already in a parlous state," even before Macron's snap election call, adding that "the prospect of a less fiscally responsible new government" could worsen the situation.
Fiscal Policies and Sovereign Debt Concerns
Renoult emphasized that France's government debt is on an "unsustainable path." According to ABN AMRO's baseline scenario, if the RN party gains a relative majority in parliament, it could lead to a cohabitation government with President Macron. This scenario could result in unsustainable fiscal policies and a less cooperative stance towards the European Union (EU).
Both far-right and far-left parties advocate for expansionary fiscal policies and express significant opposition to EU integration. The RN's policy proposals include indexing pensions to inflation (€27.4bn), lowering the retirement age from 64 to 62 (€22bn), and reducing VAT on energy from 20% to 5.5% (€11.3bn). However, some measures may face constitutional constraints and conflict with EU law, which requires a minimum VAT rate of 15%.
Renoult warned that under the current proposals, an RN-led government would result in persistent deficits above 6% in the coming years, while an NFP-led government could push the deficit to nearly 8%. "The net effect would still put government debt on an unsustainable trajectory," she added.
Impact on French and European Bonds
In a worst-case scenario, financial markets, combined with pressure from European authorities, could accelerate France's fiscal reckoning. French bonds have already underperformed since the snap election announcement, and ABN AMRO expects the OAT-Bund spread to remain wide until the election outcome and subsequent policies are clear.
The underperformance of French bonds has led the 10-year bond yield to trade above its Belgian counterpart and align with or slightly exceed those of peripheral countries like Portugal, which have lower credit ratings. The future direction of French bonds will depend on the governing party for the next three years.
Renoult cautioned that if a future French government pursues fiscally reckless plans, the market might lose trust in the country's debt, pushing the 10-year French spread well over the 100 basis points level. Such a scenario could result in France being treated similarly to lower-rated countries, effectively becoming a "crossover peripheral."
Opportunities for Investors
Despite the uncertainties, Renoult noted that the situation might present "attractive opportunities" for investors. Once political uncertainties ease, investors could find favourable yields by re-entering the European debt market, particularly with debt from countries with strong economic fundamentals such as Spain or Portugal.
As France approaches its parliamentary elections, the potential impact on its fiscal policy and the European sovereign debt market looms large. Investors and policymakers alike are closely watching the developments, anticipating the direction in which one of Europe's largest economies will head.
Source: Euronews