Europe’s political shifts, French scenarios and market implications

Samy Chaar, Chief Economist and CIO Switzerland, and Luca Bindelli, Head of Investment Strategy, also contributed to this paper.

Key takeaways:

• European Parliament elections kept the centre-right status quo in place, but hint at deeper shifts ahead in France and Germany
• Political uncertainty in France following the announcement of snap parliamentary elections triggered higher sovereign yields and equity market weakness
• We examine three scenarios. While a majority government led by either the right-wing, or the left-wing coalition, would raise risks around France’s fiscal outlook, the most likely outcome is a hung parliament which would mean moderately higher uncertainty but likely little policy change
• The European Central Bank’s intervention mechanisms mean that the eurozone does not face the same existential threats as its sovereign debt crisis of a dozen years ago.

European Parliament elections this month left the political centre-right in place but precipitated the potential for a deeper political shift in France while leaving an already fragile German government even weaker than before. We examine French political scenarios ahead, their market implications and secondary effects for European assets.

Elections between 7-9 June confirmed the centre-right’s overall political majority in the European Parliament, conveying at the surface a message of political continuity at EU level. A centrist majority of just over 400 seats out of the Parliament’s 720 total has made a re-election of Ursula von der Leyen as European Commission President for a second term look increasingly certain. However, deep political shifts at the national level are now a real possibility in core EU member states. In France, President Emmanuel Macron’s response to Marine Le Pen’s Rassemblement National (RN) victory in the single-round European Parliamentary elections led to the dissolution of the National Assembly, and the snap legislative elections now taking place. Markets reacted immediately, pushing 10-year French sovereign bond (‘Obligations assimilables du Trésor,’ or OAT) yields from less than 3% to just above 3.30% (and widening the spread versus German Bunds to 78 basis points). France’s CAC40 index is 9% lower over the month and barely flat year to date, while Germany’s DAX declined 4% over the month, although it remains 7% higher than at the beginning of this year.

Hung parliament and cohabitation until presidential elections in France

Unlike European parliamentary elections’ proportional voting system, France’s two-round process for its national chamber creates a formidable hurdle for any party to form a working majority. In each of France’s 577 constituencies, unless a candidate gathers more than half of all votes in the first round, a run-off follows between the first and second candidates, plus any other who gathers more than 12.5% of registered voters. We therefore anticipate, as a base case, a hung parliament with no party scoring 289 seats and able to gain an absolute majority through the remainder of President Macron’s term which ends in April 2027.

Given the RN’s strong results at the European level, we might expect it to nevertheless win a relative majority. That would allow the RN to lead a government in a cohabitation scenario, consisting of President Macron from Renaissance plus an RN-led government. In terms of economic policy, such a scenario would not be very different from any other minority government scenario as legislation in a hung parliament would be difficult to pass, regardless of who leads the government. France has historically experienced several periods of cohabitation: for example between President François Mitterrand and Prime Minister Jacques Chirac in the late-1980s, or between then-President Chirac and Prime Minister Lionel Jospin in the late-1990s-early-2000s. This cohabitation would probably go down as one of the more difficult ones, with the possibility of protests and potential disruptive actions by opponent forces across France for some time.

Things would look different, if compared with our current assessment, one political group gained an absolute majority in the French parliament. We see a probability of 15-20% that the RN party could achieve this, and a probability of less than 10% that France’s left-wing parties achieve such a high share of the vote. In no case do we expect President Macron’s party Renaissance getting enough support to win an absolute majority.

The table below summarises three scenarios and their implications based on the economic policies and relations with the EU, as well as their macroeconomic and financial market implications.

 

French legislative elections (30 June and 7 July) full scenario analysis
 

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Political threats to the macroeconomic picture

Recent macroeconomic developments have been broadly constructive, with a global trend towards disinflation allowing central banks, in particular the European Central Bank, to take their first steps towards easing monetary policy. Political and geopolitical risks abound and threaten this outlook. While the current focus is on the upcoming French elections, a UK general election follows on 4 July, with outcomes and implications that look clear-cut. In November, and more importantly for the rest of the world, the US holds its elections. If the French election results in a cohabitation with a hung parliament, our base case economic outlook for the eurozone remains on track. That should see French equities recover after the second round of the elections, offering a potential entry point for investors. On the other hand, if a new parliament emerges with a governing majority, we expect a more uncertain economic outlook for the eurozone. This would create the greatest risks for other European assets such as eurozone sovereign bonds and the euro. We would expect French equities to continue selling off, especially in the case of a left-wing majority French government.