French stalemate not a severe scenario for markets

As most analysts expected, the French parliament on Wednesday brought the metaphorical guillotine down on Prime Minister Michel Barnier’s minority government. The no-confidence motion, brought by an alliance of left-wing parties while Barnier was attempting to pass a budget, was supported by Marine Le Pen’s far-right National Rally party.

For those less familiar with the intricacies of French politics, it is important to underline that the prime minister is appointed by, and is the second highest ranking official after, the president (for now, that remains Emmanuel Macron). Presidential elections take place every five years, as do parliamentary elections. The president can choose to dissolve parliament, which president Macron did earlier in the year, but this has no impact on the tenure of his presidency, which ends in 2027. The president can dissolve parliament again, but 12 months have to pass in between, which means Macron can only do this from July 2025. With a parliament broadly split into three, an ousted PM and roughly two and half years left in the post, Macron is facing pressure to resign as this is seen by some (Le Pen in particular) as the only way to break the parliamentary deadlock.

That rather turbulent paragraph above contrasts sharply with the calm reaction in financial markets on Thursday morning. At time of writing the euro is unchanged, French government bond (OAT) yields are 3bp lower and their spread to German Bunds has narrowed slightly. French credit is also having an uneventful day, with some weakness in spreads but definitely no panic.

Part of the reason for the lack of reaction is that the spread between 10-year OATs and Bunds has already widened from around 55bp at the beginning of the year to just over 80bp today. France might have a lot of problems, but it is still a AA- rated government and OAT spreads are not a million miles away from the average for investment grade corporate bond indices, so there is plenty of bad news already priced in.

Another reason is that extreme scenarios seem unlikely. As opposed to previous problematic episodes in the Eurozone, there is no imminent threat of a “Frexit”. In fact, one could argue that support for Le Pen’s party has grown in recent elections precisely because she has stopped campaigning for this. Moreover, a US-style government shutdown scenario is not on the cards; if there is no support for a new budget, then a version of 2024’s would apply next year. This means the French government can continue receiving taxes, spending monies and most importantly paying bond coupons. Therefore, from a markets perspective the worst-case scenario here is far less damaging than previous examples of government budget stand-offs, such as those over the US debt ceiling (where a technical default was the worst-case), or Italy’s situation a few years ago where there was a small threat of a euro exit.

There are a few scenarios that could play out in the next few days. The most likely is that Macron appoints a new PM with the aim of getting a 2025 budget through parliament, though it remains to be seen if he chooses someone more closely aligned with Le Pen. For markets, it is difficult to see a breakthrough regarding the budget. As mentioned earlier, the parliament is split in three and no one seems in any hurry to agree on a coalition of any sort.

However, we don’t think Barnier’s removal is any worse than a scenario where he stayed in place at the expense of the budget deficit being addressed. In the meantime, we think the impact on growth will show up in the investment component; with no clarity on their tax bill, companies will likely wait and see what happens before embarking on capital expenditure plans. At the same time, private consumption, which accounts for the largest percentage of French GDP, is unlikely to be greatly affected in the short term.

While the political stalemate is certainly not good news for French corporates, and therefore growth, we don’t expect growth projections to be revised dramatically lower as a result of Barnier’s removal. The macro environment in the next few quarters is likely to be one of modest growth, inflation close to target, lower interest rates as the ECB continues to cut, and contained default rates, not dissimilar to the trends this year in many ways.

That said, French assets do not look outright cheap or expensive to us. The orderly underperformance they have suffered versus European peers is justified, but we do not think an obvious entry point or exit point has opened up.