France’s Minority Government Drama Stirs Uncertainty

Editors’ Note: MarketMinder Europe favours no party nor any politician. We assess developments for their potential market impact only.

Here is a statement that seems intuitively true but is often hard to prove: Stocks hate high and rising uncertainty and love falling uncertainty. Often, we find the effect plays out during a bull market (long period of generally rising equity prices) and results in high-uncertainty countries’ stocks underperforming but still rising. One might guess that they would be up more with the benefit of clarity, but it is always just that—a guess. Every now and then, though, we get a clear example. Such seems to be the case with France lately, in our view.

French stocks have swung on political ups and downs since mid-year, presently posting negative year-to-date returns in euro terms—one of two nations in the MSCI World Index trading in the red.^[i] And behind it all, in our view, is largely local politics.

French markets tumbled in June as President Emmanuel Macron called a snap legislative election and the populist National Rally (NR) and leftist New Popular Front (NPF) looked strong out of the gate.^[ii] When neither emerged with a majority, rendering earlier widespread speculation of extreme policy overblown, markets stabilised.^[iii] Then came a nice rally in August and September as Macron worked to install a minority government.^[iv] His appointment of former Brexit negotiator Michel Barnier as prime minister seemed to help sentiment further, indicating the NPF would have minimal influence over policy.^[v]

But as September wound down, Barnier telegraphed sweeping tax hikes to address France’s deficit, prompting speculation around both an anti-growth budget and a government collapse if the budget couldn’t get through the National Assembly.^[vi] The budget, released in early October, seemingly confirmed this chatter with €60 billion in tax hikes and spending cuts—which the NPF and NR deemed a non-starter.^[vii] French stocks sagged from late September through November’s end.^[viii]

Now December has seemingly started on a down note. In recent days, Barnier made some concessions on the budget in hopes of getting the NR’s blessing.^[ix] But on Monday, it became clear he lacked the votes needed to pass it, so he and Macron pushed it through via presidential decree instead—invoking the controversial article 49.3 of the French constitution, the same tactic Macron used to finalise contentious pension reforms last year.^[x] The NR and NPF responded by filing no-confidence motions.^[xi] They look set to get a floor vote Wednesday, which could spell the end of Barnier’s government and block the budget decree—though Macron said on Tuesday he expects the government will survive the vote.^[xii]

In our view, this is basically a giant stare down. Barnier argues that if his government falls, bond yields will spike, sparking a debt crisis.^[xiii] But the NPF and NR say their red lines are truly red and claim widespread talk of a run on French debt are overblown.^[xiv] Will anyone blink?

How it all pans out is unknowable, in our view. Maybe the NR gets enough of what it wants to back off and Barnier stays put. Maybe they bring down the curtain, making this the first ousted government since the guillotine was mothballed.^[xv] The last time a French PM lost a no-confidence vote—Georges Pompidou in 1962—his party won the ensuing snap election and he got his job back.^[xvi] French law prohibits another snap election until next summer, so an immediate return for Barnier could be off the table. Instead, we think France would likely get another protracted government formation process, resulting in either another minority government, a disparate coalition or a technocratic government.

So, in our view, uncertainty is high. But eventually it will fall. Wednesday will bring immediate answers on the government’s and budget’s staying power. If both fall, then we will most likely get a season of uncertainty and budget bickering. But as things gradually slide into place, we think stocks should be able to price in the evolving landscape and move on.

As for debt crisis fears, we think they are misplaced. Not because we side with anyone in the political debate, but because France’s debt service costs don’t break the bank. Publications we follow often compare government debt and deficits to gross domestic product (GDP, a government-produced measure of economic output.), but they aren’t the measures that matter, in our view. GDP is the flow of all economic activity in a given year. Debt is an accumulated stock. The deficit is an accounting entry. Three. Different. Things. Governments don’t pay debt with annual economic activity. Nor does economic activity finance the deficit.

What really matters is interest payments—the cost of servicing debt—and how that compares to government revenues. As long as debt interest doesn’t hog a huge share of tax revenues, then we think public finances are in fine shape. France’s central government interest costs were 9.9% of tax revenues last year.^[xvii] This is up from 6.6% in 2020, but it is below the entirety of 1992 – 2015 (and it is also down a smidge from 2022).^[xviii] If France’s finances didn’t implode when interest gobbled nearly 14% of revenue in 2011 and 2012, then why would they suddenly do so now?

In our view, the deficit is a political issue, sparked by eurozone rules, not an economic one. We think the market is basically telling investors this, with French 10-year yields falling as the latest political tensions escalated.^[xix] The benchmark 10-year OAT yield is down from 3.18% on 7 November to 2.93% now, echoing a similar drop in German yields.^[xx] It is also down from early June, before the snap election was called.^[xxi] According to our research, investors don’t usually flock to an asset where a run is imminent.

Therefore, we mostly see this as an object lesson in how stocks deal with uncertainty, a shining example that they don’t like it. We see a silver lining, though: Simply having clarity, even if it isn’t some ideal, presumably market-friendly outcome, should help. Depending on our market outlook for next year (stay tuned!), that may or may not mean a rip-roaring rally is likely. But we think it suggests French politics, currently a headwind, won’t stay that way indefinitely.