By Karsten Junius, chief economist at J. Safra Sarasin Sustainable Asset Management
French elections provided a major surprise as the left-wing alliance unexpectedly came in first, followed by Macron’s centrist Ensemble and the far-right Rassemblement National (RN) in third place. Uncertainty is set to remain, with several government options possible: a technocratic government, a left-wing minority government, or a centre-left “Grand Coalition”. Any outcome would likely stall President Macron’s reform agenda and may even reverse some of his achievements. Therefore, France’s debt dynamics will likely deteriorate and keep credit ratings under pressure. A left-wing minority government would be the most unstable and likely provide the least market-friendly policy agenda. A technocratic government should provide more stability but would be limited in time and in its scope to implement reforms. The most market-friendly, yet most unlikely, outcome would be a centre-left “Grand Coalition”. Given that political risks are set to remain elevated, we would advise to stay cautious with regard to French assets and only gain exposure selectively.
The second round of French elections ended with a big surprise as the left-wing alliance (Nouveau Front Populaire, NFP) came in first with 180 seats, followed by Macron’s centrist Ensemble with 163 seats. The far right, Le Rassemblement National (RN), which was widely expected to win a majority after their strong result in the first round, came in third, with 143 seats only. Forming a government will not be easy, given that France is not used to coalition governments and the political compromises that are necessary for that. As a result, a prolonged period of uncertainty und political negotiations is likely.
Prime minister Attal offered his resignation after Sunday’s vote, which was rejected by President Macron, such that he will stay on as a caretaker until a new government has been formed. Typically, the President would nominate a new PM from the largest faction in parliament. Yet this is only likely to happen after several weeks of negotiations. Political uncertainty will thus remain high until a new government has been formed. We see three most likely outcomes:
- A minority government lead by the NFP
- A technocratic government supported by the three major parties
- A “Grand Coalition” between parts of NFP, Ensemble and Les Républicains
The first and second would be unstable outcomes and permanently face the risk of a vote of no-confidence. Passing laws would likely become a major challenge. A minority government would have to try and find majorities for every piece of legislation and may have to resort to the use of article 49.3 of the French constitution in order to pass legislation. This article allows laws to be passed without a parliamentary majority but is tied to a vote of confidence for the government. On the other side, a technocratic government would be very limited in what it could achieve. Therefore, it would be difficult to pass meaningful legislation, and we would expect ongoing instability for at least one year until the President can dissolve the Assembly again.
The third (a “Grand Coalition”) would be the preferred outcome as it would likely be more stable than a technocratic or a minority government. Yet parties would need to learn to cooperate, which is not in their DNA. It could also require the National Popular Front to split as the combined seats of the centre parties (Republicans & Ensemble) would not be sufficient to form a majority government. That looks unlikely for now.
In any case, President Macron would have to govern in the form of a so-called cohabitation – that means that his Prime Minister comes from a different party than his own. French politics will therefore likely move to the left and will not only put an end to President Macron’s reform agenda but may even reverse past achievements. Consequently, France’s debt dynamics are likely to worsen. The EU Commission (EC) has already opened an Excessive Deficit Procedure against France on the basis of current projected deficits.
The fact that France is on a fiscal path that is unsustainable over the medium term has been noted by rating agencies. S&P and Fitch downgraded the French sovereign rating to AA- in 2024 and 2023, respectively. Moody’s still keeps France at Aa2 but might also downgrade it in 2024. Absent a visible effort to consolidate government finances, pressure on French government bond ratings will not disappear.
France’s debt-to-GDP ratio relative to the rest of the euro area has worsened over the past few years, in part reflecting slower growth. If we relate euro area credit spreads to the latest official debt-to-GDP numbers, spreads to Bunds look too tight. We also note that the ECB will be unwilling to provide support to French bonds if the reason for higher spreads is reckless fiscal policies. We find that the risk/return trade-off for French government bonds is not attractive at current levels and would therefore advise caution.
Even though the most radical policies of the far-right and the far-left are unlikely to go through, French equities remain exposed to potential headwinds from a left-leaning government. These may come from three sides: i) higher taxes, ii) lower growth and iii) higher fiscal uncertainty.
Once formed, a left-wing minority government would likely be the most disruptive outcome for equity markets, given the largely unfunded fiscal promises of the NFP. These would likely lead to tax increases, including the reversal of corporate tax rate cuts under the last administration. The pledge to curb energy costs would also weigh on the French utilities sector, while banks may predominantly be affected by elevated funding costs due to wider OAT spreads to Bunds.
The best yet unlikely outcome for equities would be a centrist coalition government, which may aim to improve the fiscal situation such that France could be released from the Commission’s excessive deficit procedure. It may also retain some reform momentum and not threaten previous achievements. We would expect French equities to rally if such a coalition were to shape up, with French financials and utilities leading the rebound.
Lastly, a technocratic government would likely provide an increased level of stability but would only have a limited mandate for reforms. Once formed, it would provide scope for an equity market rebound. Yet it seems unlikely that France’s fiscal trajectory would improve materially under such an administration, given the required broad-based support in parliament. We would expect any substantial equity market rebound to be short-lived in such a scenario.
