France’s messy politics hint at broader unease for investors

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Last May, the rating agency S&P Global downgraded the rating of French government bonds, thus urging the country’s politicians to get a grip.

“Political fragmentation adds to uncertainty about the government’s ability to continue implementing policies that increase economic growth potential and address fiscal imbalances,” he said in a note accompanying his decision to downgrade the country’s rating by one notch to AA-, which is still a sign of quality but nonetheless a downgrade.

That was on May 31, before the European parliamentary elections set off a chain reaction of national votes that ended Sunday with a parliament without an absolute majority. The far right did well, but not enough to confront the rise of a mishmash of centrists, communists and environmentalists who worked together and rallied to the cause of keeping Marine Le Pen’s National Rally out of the prime minister’s office.

What follows will be a long period of bickering, posturing and tense demands by rival politicians to make the one true voice of France heard. In other words, as far as markets are concerned: plus ça change.

At a news conference on Monday, Benjamin Melman, global chief investment officer at Edmond de Rothschild Asset Management in Paris, said the failed election result meant there would be no “Liz Truss moment” of bond market fireworks triggered by a radical change in fiscal policy. But, he added, “I don’t see a solution to the medium- and long-term problems that France faces.” The country should brace itself for one or two more downgrades from ratings agencies, he added, and for new parliamentary elections in a year or two.

Politically, everything has changed in France. Economically, what really interests investors, less. That is why so far (and we must remember that we are only at the beginning, many things can still go well or badly from here) we have seen only temporary declines, of the euro, of French stocks and of the country’s government bonds.

In fact, the inaction, bickering and posturing, while harmful to democracy, are in many ways exactly what investors want to see continue. They were nervous about a far-right government. Even though the RN had promised to play nice with the markets, the prospect of the party spending years fighting with the EU over budgets ran the risk of France becoming the new Italy, historically vulnerable to fluctuations in bond markets. In the worst case, the RN could revive its penchant for Frexit.

But they were also worried about the prospect of a far-left victory. In fact, that remains the case. As Mark Haefele, chief investment officer of UBS Global Wealth Management, pointed out on Monday, one option now open to President Emmanuel Macron is to appoint a prime minister from the party that won the most seats, in this case the far-left New Popular Front.

“An NFP government would likely seek to reverse recent pension and unemployment reforms, raise the minimum wage, and not engage in fiscal consolidation, in our view,” Haefele and his team wrote Monday. “We believe that the NFP program, if implemented as proposed, could lead to a significant deterioration in the already high budget deficit.” That’s not a very positive outcome for the French government’s borrowing costs, which is not a very positive outcome for French businesses. That’s why, for many, an ineffective hung parliament is the best of a series of less-than-palatable options.

This drama will weigh on France for some time to come, but also on all of Europe. “It is possible that asset allocations to French stocks will be reduced permanently,” said Frédéric Leroux, a member of the strategic investment committee of the French investment company Carmignac.

Moreover, all this is yet another reason for international investors outside Europe to steer clear of the continent. “The problem is the perception that Europe has from outside Europe,” said Nicolas Faller, co-CEO of asset management at Swiss wealth manager UBP. “Every year, we have a good reason not to invest in Europe,” he said. Something always happens that dulls the interest of clients in Asia, for example. Why bother understanding the complexities of Europe when the United States is moving fast, breaking things and delivering solid returns on the market?

Overall, the result is a surprise. Opinion polls predicted a far-right majority that failed to materialize. It is a useful reminder not to put too much stock in opinion polls ahead of the US elections looming later this year. But as Rabobank analysts said in a note: “This is a surprise more in form than in substance… The result is the same, in that we are now likely to face a period of political paralysis.” Plus ça change indeed.