Risk aversion prevails in markets amid French political uncertainty

Investment sentiment soured amid political uncertainties in France, leading to significant market reactions. The French benchmark, the CAC 40, tumbled 6.23% last week, reaching a nearly five-month low and wiping off approximately €187 billion of market value. The euro also weakened against the US dollar, dropping to just above 1.07 early in the Asian session on June 17, marking its lowest level in six weeks.

In contrast, safe-haven assets such as the US dollar, gold, and the Swiss Franc saw gains as investors grew increasingly concerned about potential spill-over risks from the European Union’s political landscape into global markets. 

French financial stability sparks concerns

The potential defeat of Emmanuel Macron by far-right leader Marine Le Pen poses a significant risk to France’s financial stability. French Finance Minister Bruno Le Maire warned that the country could face a debt crisis if the far-right wins the election in July, drawing parallels to the turmoil when Liz Truss became the UK Prime Minister two years ago. According to European Commission projections, France’s debt-to-GDP ratio, which is the second highest in the Eurozone behind Italy, is expected to reach 112.4% in 2024.  

The French 10-year bond yield plunged by as much as 24 basis points last week after the French Prime Minister called for a snap election amid Le Pen’s far-right triumph over his centrist political party in the EU parliamentary elections. Consequently, the spread between government bond yields in Germany and France surged to 81 basis points, the highest level since August 2012. 

Marine Le Pen, leader of the far-right National Rally, has proposed reducing the retirement age for pensions and cutting the value-added tax on fuel, which could lead to additional spending of more than €100 billion a year. While some measures may not take effect immediately if her party wins the election, the already heavily indebted country would face higher deficits, breaking the EU’s debt level allowances and overturning France’s plan to reduce its debt-to-GDP ratio by 5.1% in 2024. Furthermore, S&P Global ratings downgraded France’s credit score last month, citing a projected deficit level of 3% of GDP until 2027. 

The potential victory of Marine Le Pen, leader of the far-right National Rally, poses a significant risk to France’s economic stability. Le Pen has advocated for a “France first” and protectionist agenda, including strict restrictions on immigration, workers, and foreign investments. This stance puts President Emmanuel Macron’s €15 billion “Choose France” plan at risk. The plan, highlighted by a key investor summit held at the grand Palace of Versailles in May, aimed to attract foreign investment to bolster France’s economy.

Moody’s recently issued a warning of a “credit negative” outlook for France due to these political uncertainties. Last week, this led to a 35 basis points spike in premiums on French 10-year government bond yields as investors demanded higher risk premiums amid concerns about the country’s financial security. 

ECB sees no immediate risk in French bond markets

Policymakers at the European Central Bank (ECB) reportedly have no plans to intervene in the French bond market amidst recent turmoil, according to Reuters. The ECB has assessed that there are no systemic risks currently affecting French financial markets, and therefore, it does not foresee the need to implement an emergency bond-buying program known as the Transmission Protection Instrument (TPI).

The TPI, which allows the ECB to conduct unlimited purchases of public debt, was introduced to address fragmentation in eurozone bond markets and ensure the smooth transmission of monetary policy across member states in 2022. Although the tool remains available, it has not been activated formally.

ECB officials emphasised that the resolution of any turmoil in the French markets lies primarily in the hands of French politicians. This stance underscores the ECB’s cautious approach, maintaining its policy of non-intervention unless systemic risks emerge that threaten the stability of financial markets across the eurozone. This scenario mirrors previous instances where the ECB used existing tools, such as flexible reinvestment of redemptions under the Pandemic Emergency Purchase Programme (PEPP), to address bond market turmoil. This was notably seen during political uncertainties and broader economic challenges in Italy in 2022.