France’s Minority Government Drama Stirs Uncertainty

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

Here is a statement that is intuitively true but, sometimes, hard to prove: Stocks hate high and rising uncertainty and love falling uncertainty. Often, the effect plays out during a bull market and results in high-uncertainty countries’ stocks underperforming but still rising. You can 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 is the case today with France.

French stocks have swung on political ups and downs since mid-year, presently posting negative year-to-date returns in US dollar terms—one of three nations in the MSCI World Index trading in the red. And behind it all 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. When neither emerged with a majority, rendering earlier fears of extreme policy overblown, markets stabilized. Then came a nice rally in August and September as Macron worked to install a minority government. 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.

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

Now December has started on a down note. In recent days, Barnier made some concessions on the budget in hopes of getting the NR’s blessing. 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 finalize contentious pension reforms last year. The NR and NPF responded by filing no-confidence motions. They look set to get a floor vote Wednesday, which could spell the end of Barnier’s government and block the budget decree.

This is basically a giant game of chicken. Barnier argues that if his government falls, bond yields will spike, sparking a debt crisis. But the NPF and NR say their red lines are truly red and claim fears of a run on French debt are overblown. Will anyone blink?

We suspect there will be a lot of phone calls and negotiations over the next two days, but how it all pans out is unknowable. 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.^[ii] 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. French law prohibits another snap election until next summer, so an immediate return for Barnier is probably off the table. Instead, France would likely get another protracted government formation process, resulting in either another minority government, a disparate coalition or a technocratic government.

So 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 get a season of uncertainty and budget bickering. But as things gradually slide into place, 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—as we showed in September—France’s debt service costs don’t break the bank. The deficit is a political issue, sparked by EU rules, not an economic one. The market is basically telling you this, with French 10-year yields falling as the latest political tensions escalated. The benchmark 10-year OAT yield is down from 3.18% on November 7 to 2.93% now, echoing a similar drop in German yields.^[iii] It is also down from early June, before the snap election was called. Investors don’t exactly 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. There is a silver lining, though: Simply having clarity, even if it isn’t some ideal, nominally 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 it does suggest French politics, currently a headwind, won’t stay that way indefinitely.