French Political Uncertainty Is Likely a Fleeting Headwind

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French stocks tumbled last week following President Emmanuel Macron’s unexpected decision to call snap parliamentary elections. Headlines are full of speculation about the chances of a populist victory radically altering policy, with some drawing parallels to the early 2010s’ euro crisis. But cool down. This looks like a sentiment reaction to us—one we expect to prove fleeting.

For the week, French stocks fell -7.3% while 10-year bond yields rose from 3.10% the previous Friday to as high as 3.25% last Wednesday—before reversing back to 3.11% on Friday.^[i] Meanwhile, German yields fell sharply, from 2.62% to 2.35%.^[ii] This widened the spread between France’s 10-year and Germany’s 10-year—a popular measure of perceived credit risk—to 0.76 percentage point by the week’s end, the highest in seven years.^[iii]

The cause: Politics. Many seemed to fear a big win for the nationalist National Rally (NR) in the snap legislative vote. That would give NR the ability to override any Presidential veto and implement its perceived anti-business agenda (which includes higher public spending and taxes and restrictions on foreign acquisitions and stock buybacks). The widening bond spreads hit sentiment toward banks, which are big bondholders, hardest. Lesser-exposed firms in French Industrials, Discretionary or Consumer Staples sectors fell, but not nearly as much overall.

As we wrote last week, the radical policy shifts hyped in headlines are unlikely to materialize. Macron likely isn’t going anywhere. Barring his resignation, which he has denied is on the table, he will remain president regardless of the vote’s result. Macron also likely recognizes the recent European Parliamentary election was a protest vote and rebuke of his government. Turnout illustrates this. French turnout for EP elections was below 45%, while national elections typically see over 70%.^[iv] Macron is likely banking on French voters making a different choice when it comes to domestic politics, and higher turnout could tilt the scales away from NR.

Moreover, no party is likely to win a majority. Despite the NR’s current momentum, some factors are working against it. Fielding 577 candidates in 577 constituencies in less than a month is a tall order, and the NR’s nationwide ground game isn’t great. Even when its co-leader, Marine Le Pen, ran a strong presidential campaign in 2022, the party won just 89 seats. Current party president Jordan Bardella has less baggage but is untested. As for Macron, his party announced over the weekend it wouldn’t field candidates in other parties’ strongholds, focusing his campaign on seats where his party has better chances. This reduces the risk of centrist parties splitting the vote.

Should the NR take a majority, Macron has to select the party’s candidate as prime minister. That sets up an arrangement known as cohabitation, which has happened three times since 1958’s constitution created the Fifth Republic. A PM’s influence during cohabitation is tied to parliament’s post-election structure. An NR prime minister could walk back some of Macron’s reforms—or push forward with their national-level agenda—but they will likely have to be selective or risk facing no-confidence votes in parliament. In our view, that is a recipe for watered-down policies. And note, even under the widely feared scenario of an NR government with a legislative majority, passing controversial laws (e.g., a windfall tax) won’t automatically derail French markets. The details matter, as no legislation is automatically good or bad. See windfall duties in Spain and Italy, which haven’t upended markets there.

To us, the French saga looks mostly like the latest chapter in Europe’s extensive recent history of fearing so-called populism. Fears surrounding unexpected political developments may roil markets for a spell, but the impact tends to be fleeting. Go back two years to the UK, when then-new Prime Minister Liz Truss’s mini budget spooked many experts who worried the plans amounted debt-fueling unfunded tax cuts—somewhat resembling budget fears in France today. The short-term market reaction was swift, as UK gilt yields soared from 3.77% on September 23 to 4.55% on October 10.^[v] The episode forced Truss to resign after only 44 days in office, but markets quickly calmed.

Or take Italy in 2018, when the nationalist League and anti-establishment Five Star Movement (M5S) drove fears of an unshackled populist government. Yes, there was a lot of volatility in May 2018 when the populists’ struggle to form a government spurred worries of a new election—and that uncertainty likely contributed to Italian stocks’ falling about -13.9% in the month’s second half.^[vi] Yet things eventually quieted down, and the populist League-M5S coalition didn’t accomplish much—and lasted just a little over a year.

Fears of a Le Pen-led party in power aren’t even new. The aforementioned French-German 10-year yield spread was higher in February 2017, around the time Le Pen (whose party was then called the National Front) declared her presidential candidacy—which stirred even more worries about radical change than today (e.g., France’s exiting the euro).^[vii] Seven years later, Le Pen rebranded her party (from National Front to National Rally) and moderated on some of those controversial policies (e.g., reforming the EU instead of leaving the common currency). As always, watch what politicians do, not what they say.

H/T Capital Markets Analyst Larissa Murray