The French President’s decision to call a snap election last week, after his centrist alliance was beaten in the EU parliamentary elections by the far-right National Rally, has pushed the country into a turbulent political setting, adding to investors’ risk aversion stance as far as European asset markets are concerned.
Namely, Marine Le Pen’s National Rally received more than double the 15 per cent or so share of votes that President Emmanuel Macron’s Renaissance Party received, prompting Macron to call a snap vote three years ahead of when an election was due.
In a statement on Monday, Christine Lagarde, president of the European Central Bank (ECB), emphasised the ECB’s close monitoring of financial market stability after Macron’s election call sparked a significant repricing.
Namely, in the aftermath of the announcement, markets experienced substantial declines, with the euro plummeting to a 22-month low against the pound. Friday saw a severe sell-off amid ongoing political uncertainty with French shares falling 6.2 per cent. Additionally, the gap between the French and German 10-year bond yields increased by 29 basis points indicating that investors are demanding an increased premium to hold French debt.
At the time, Jim Reid, strategist at Deutsche Bank, said: “For reference, the last time it was this wide in 2017 came just before the first round of the presidential election that year, when Macron came first and set up a run-off in the second round against Marine Le Pen. Then spreads tightened again after Macron’s first-round win, as markets moved to price in a strong likelihood of a Macron presidency”.
Addressing the reasons behind “all the fuss”, which also significantly dented European shares, AMP’s chief economist Shane Oliver said that, put simply, investors are fearful that far-right success could lead to more populist policies and greater economic uncertainty.
Moreover, he explained, investors fear a far-right win in the French election could ultimately threaten a break-up of the eurozone which, if it occurs, would plunge the world’s third biggest economic region into financial chaos, which would ultimately weigh on global growth.
Threats to the global economy, Oliver said, naturally pose a risk for the Australian economic outlook.
“This is the same as we saw during the eurozone crises last decade which saw a flow on to Australian shares,” the chief economist explained.
This crisis peaked in 2012 after various measures to strengthen European integration and the ECB’s commitment to “do whatever it takes to preserve the euro”, which was backed by various policy tools that could be triggered at times of instability in bond markets. But ever since then, various flare-ups have occurred, Oliver cautioned, referring to them as a “recurring soap opera” which has so far sparked fears of a Grexit, Itexit, Frexit, and so on.
“That such fears keep arising reflects the fundamental flaw in the euro,” Oliver said.
“Having a monetary union without common budgetary policies is problematic and differences in competitiveness, work ethics, and savings are immense across Europe.”
What will a far-right government do?
The first round of the French election is on 30 June, with run-off elections on 7 July.
The first round often sees more than 10 candidates in each electorate with only those receiving support from more than 12.5 per cent of registered voters moving to the second round.
According to Oliver, the EU election suggests that the far-right National Rally has a chance to form government in its own right or with an alliance with other right-wing parties. But, he tipped, French polls are not decisive and another broad centrist alliance could be the outcome.
However, if the far right were to win, Oliver said the government could go one of two ways.
“It might go hard to implement its policies to cut tax on energy, exit the EU electricity market, unwind Macron’s pension and other reforms and be less compliant with EU fiscal rules. This could set up conflict with the European Commission, result in an adverse market reaction and eventually set France on a path to exit the euro. This would be bad for markets but could play into Macron’s strategy with the turmoil leading to National Rally’s rejection in the 2027 elections,” the chief economist said.
The other option is that it might follow a similar path to Italy’s Prime Minister Meloni, from the right Brothers of Italy, and come down hard on social issues like immigration while adopting market-friendly, EU-compliant economic policies.
“Of course, markets have no way of knowing the election outcome and which way it will go, so the uncertainty is weighing,” Oliver said.
“With France at the centre, along with Germany, of the EU and the euro, anything that threatens its commitment is a big concern.”
Oliver is, however, confident that there is still hope a return to a full-blown eurozone crisis will be averted, and the euro will yet again survive without a series of exits.
“First, the commitment to the European Union and the euro is very strong,” Oliver said.
“While the euro is flawed economically, it’s part of a grand political vision that’s led to a long period of peace across Europe and rapid growth in prosperity that neighbouring countries envy. As a result, most European politicians don’t want to give up on what has been a successful political journey towards a more united Europe. Particularly at a time of increasing geopolitical threats from Russia and a less certain commitment from the US. So European leaders will likely continue to find a way to make the economics work.”
Second, Oliver noted, public support for the euro is high with 67 per cent of the French and 69 per cent of people in the eurozone agreeing that the euro is a good thing for their country. As such, Oliver’s third reason for optimism is that far-right parties, including Le Pen’s National Rally, have dropped leaving the euro from their policies, having realised it prevents them from achieving broad support.
“Fourthly, surging bond yields will likely influence any National Rally government to modify its less market-friendly economic policies,” Oliver said, adding that finally, the ECB does still have tools at its disposal to stabilise national bond markets if there is a threat to the application of its monetary policy across Europe.
“While investment markets are nervous and a far-right win in the French elections could see that nervousness rise further before it falls, a return to the crisis days of last decade and a serious threat to the euro is unlikely,” Oliver said.
“In this regard, it’s noteworthy that bond spreads to Germany, including in France, are well below 2012 extremes,” he added.
Deglobalisation in action
Oliver did, however, note that on the whole, the outcome of the European parliamentary elections, which did see a rise in support for far-right parties throughout the eurozone, is broadly consistent with backlash seen against free market economically rationalist economic policies.
“The political pendulum is continuing to shift towards more protectionism, industrial policies, tougher immigration policies and bigger government – both in terms of spending and regulation and slower progress towards net zero carbon emissions.
“This has been seen in the last month in the US and EU’s moves to impose higher taxes on some imports from China (notably on electric vehicles) and in the Future Made in Australia policies.
“While the economic impact of each move on their own is minor, taken together, they will mean slightly slower growth in living standards and slightly more inflation-prone economies over time.”
Ultimately, looking ahead, Oliver believes share market returns will be constrained and volatile for the remainder of the year, while bonds are expected to rally.
“The ongoing rise in support for populist policies is likely to also constrain medium term returns.
“That said, the far right is still far from dominant, and we continue to see reasonable returns from shares this year as central banks move to cut interest rates, at varying paces.”
Maja Garaca Djurdjevic
Maja's career in journalism spans well over a decade across finance, business and politics. Now an experienced editor and reporter across all elements of the financial services sector, prior to joining Momentum Media, Maja reported for several established news outlets in Southeast Europe, scrutinising key processes in post-conflict societies.
