Investors hold their breath ahead of French elections

Left and Right battle for parliamentary control

The upcoming French parliamentary elections have stirred concerns among investors and analysts. President Emmanuel Macron's decision to call early elections, coupled with the far-right National Rally (RN) leading in polls, has raised questions about France's fiscal future. However, some experts now suggest that a left-wing alliance could pose an even greater risk to the financial markets than a far-right leadership.

Potential policies and market reaction

The leftist New Popular Front (NFP) alliance has proposed significant spending increases, amounting to an additional 150 billion euros annually by 2027. While they claim this will be offset by tax hikes, investors remain wary. In contrast, the far-right RN has pledged to respect EU deficit rules, which some investors find surprisingly reassuring.

Will France face its own Truss moment?

Analysts from major financial institutions like Nomura and Jefferies have suggested that an NFP-led government would be the worst outcome for financial markets. They predict it could lead to wider bond spreads and negatively impact the euro. Some experts have drawn parallels between the NFP's approach and the unsuccessful policies of former UK Prime Minister Liz Truss.

Bonds under surveillance again

Forecasts indicate that French-German bond spreads could widen significantly if a left-wing government comes to power. Most other scenarios, including an RN absolute majority, are viewed as less concerning for markets in comparison to an NFP-led government. However, the situation remains fluid, and investors are closely monitoring developments in the lead-up to the elections.

A new eurozone crisis?

In 2016, then EU Commission president declared that France would not be subject to the same budget rules as smaller eurozone countries, ‘because it’s France’. Now, the eurozone faces a major test. A sovereign debt crisis could develop as investors reassess the country’s long-term debt sustainability. France's financial situation would act as the catalyst, prompting a mass exodus from government bonds. This exodus would cause bond yields to spike dramatically, exacerbating the crisis. To stabilise the situation, a multi-pronged approach would be needed necessary: the European Central Bank (ECB) would likely have to intervene to calm market pressures, but in the meantime eurozone assets could see increased volatility.