The European election results have sent shockwaves through traditional media and financial markets alike, primarily due to the significant shift towards right-wing parties. This reaction, however, could be seen as a pretext for investors to divest from their positions amidst growing uncertainty.
Given the political developments of recent years and the multitude of election polls, the substantial gains by right-wing parties should come as no surprise. Nevertheless, the Rassemblement National’s triumph, securing over 31 per cent of the vote in France, was significant enough to prompt President Emmanuel Macron to call for early elections—an oft-used tactic to regain political momentum.
Market reactions
The immediate consequences were stark: the euro plummeted, French equities significantly underperformed compared to the European average, and the spread on French 10-year yields reached its highest point since the post-Covid period. The prevailing narrative suggests that this political shift has suddenly heightened investors’ concerns over France’s fiscal discipline.
However, fiscal discipline has long been a contentious issue in France. Regardless of the ruling party, France has consistently struggled with fiscal policy. The accompanying chart illustrates France’s budget deficit over the years, revealing a persistent inability to maintain a budget surplus.
Budget deficit comparison: France vs. Italy
Over the 16 years since the Great Financial Crisis, France has kept its deficit below the three percent of GDP threshold only twice, averaging a budget deficit of five percent. In contrast, Italy managed to stay within the three percent limit in eight of those 16 years, despite facing severe economic challenges.
The market reaction should be viewed in a broader context. The election outcome introduces uncertainty, and markets abhor uncertainty as it forces them to confront risk. Investors aware of France’s budgetary history will be disheartened by the prospect of continued fiscal mismanagement, especially as Macron may resort to increased spending to regain voter support.
Polarised political climate
A polarised political climate, characterised by significant shifts between left and right, tends to exacerbate budget deficits. This is further compounded by rising expenditures on social security, pensions, education, healthcare, and security.
Fortunately, the ECB has already taken action by cutting interest rates, perhaps anticipating the fiscal challenges ahead.
Jeroen Blokland presents eye-catching, topical charts on financial markets and macroeconomics in his newsletter The Market Routine. He also manages his own multi-asset fund. Previously, Blokland was head of multi-asset at Robeco.