Political crises in France and South Korea aren’t market crises

Crises in France and South Korea add to the political risks facing investors. France lacks a government after opposite ends of the political spectrum united to reject a deficit-cutting budget. South Korea, whose stock market offers emerging market investors attractive valuations, may impeach its president after an attempt to impose martial law and face a period of political instability. The situation in South Korea is highly fluid as well as volatile. Both look like political rather than financial market crises.

In Paris, a no-confidence vote driven by an alliance of the left wing and far-right National Rally leaves the country without a budget for next year. The government’s opponents rejected proposals designed to address France’s budget deficit by freezing state pensions and cutting healthcare costs by raising the cost of some treatments. The immediate fiscal solution will likely be emergency legislation that rolls over existing budget arrangements, including taxes.

The immediate fiscal solution will likely be emergency legislation that rolls over existing budget arrangements, including taxes

A divided parliament is unusual in France but commonplace in other democracies, including the US until January 2025. The French parliament’s composition, with large representations from the extreme left and extreme right, is in no mood to forge compromises. That makes the formation of any replacement government challenging for President Emmanuel Macron. Another parliamentary election cannot be called before July 2025 under the constitution, and so we may see another caretaker government. Nevertheless, a political vacuum provides a form of short-term stability, since parliament will not be able to pass major economic changes.

Still, France is not in a debt crisis. From a financial market perspective, France’s high budget deficits and public debt are reflected by credit spreads. Widening French government bond spreads with their German equivalents are not triggering a rise in French yields. In fact, French government bond yields have fallen by more than 20 basis points from a month ago.

Economically, France is experiencing modest growth and the European Central Bank (ECB) is in an interest-rate cutting cycle. This should prompt French bond yields to fall further, but not exacerbate spreads. France does have the ability to finance its debt domestically and its current account deficit is more limited than in the UK or the US, for example. In the eurozone, we nevertheless prefer Spanish debt, which has comparable sovereign debt metrics, and German Bunds.

Private sector savings are offsetting French public sector imbalances, meaning that the country’s current account is broadly balanced. Overall, the political crisis comes at a difficult time with Europe falling short of the strategic investments needed to remain competitive, a slowing Chinese economy, and the uncertainties of the next US administration.

The French stock market has nevertheless reflected the nation’s political uncertainties this year. In 2024 the benchmark CAC40 index has priced in political risk, despite its key companies depending more on global than domestic markets. This creates some potential for the index to catch up in 2025, depending on three catalysts: a weaker euro, improved trade relations between China, the US and Europe and, of course, short-term workarounds for French political paralysis without radical policy change.

We continue to anticipate most currencies weakening against the US dollar, especially the euro, as the US prepares to implement a set of ‘America First’ trade policies. The ECB’s cutting cycle, which we expect to take interest rates to 1.25%, will also leave investors favouring the higher yields available from US fixed income.

We continue to anticipate most currencies weakening against the US dollar, especially the euro

South Korea’s martial surprise

If the uncertainties over France have long-term political consequences, events in South Korea were so rapid – although still highly fluid – that they have little material impact on our outlook for the economy for now. The country appears to be returning to an orderly political process but sources of potential instability remain high and risks of another martial law cannot fully be excluded. President Yoon Suk Yeol’s failed attempt to declare martial law on 3 December citing “anti-state forces” prompted astonishment, and a widespread backlash. His political opposition will try to pass an impeachment motion. If that succeeds, President Yoon will be tried by the country’s constitutional court. The odds have however recently decreased for a successful impeachment after the ruling party formally determined it would abstain from the floor vote.

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In emerging markets, we have held a preference for South Korean stocks, because growth for 2025 and valuations look attractive. The country is home to advanced semi-conductor makers and technology firms. Our preference for South Korea equities reflects sound valuations and its exposure to the tech sector. A return to orderly political processes and a stabilisation of the political situation would be supportive to the market. The KOSPI leading stock index is now down -8% year-to-date. However, a prolongation of political uncertainty with the possibility of a second second imposition of martial law, should street violence erupt in the aftermath of parliamentary votes regarding President Yoon and his family, leaves political risks associated with the KOSPI high. We will continue to monitor fast-paced developments over the coming days before determining our positioning with regard to the market.

We have held a negative view on Asian currencies, including the Korean won, since the US election

South Korea’s economic outlook could be undermined by any escalation in the political conflict, and also depends on how the Trump administration in the US rolls out its trade policy. We continue to expect the Bank of Korea (BOK) to impose two more 25 basis point cuts, taking the country’s reference rate to 2.5%, and then holding borrowing costs at this level, but there is downside risk. Inflation is close to target and economic growth will be softer in 2025. The BOK has a financial stability mandate, making it concerned by high domestic real estate prices and household debt, and so tends to intervene to smooth currency volatility. We have held a negative view on Asian currencies, including the Korean won, since the US election. We expect the dollar-won to be around 1,400 three months from now, and around 1,460 on a 12-month horizon as Asia’s currencies against the dollar will generally follow the dollar-Chinese yuan, as higher US tariffs take effect. A continued preference for US assets could see large retail investor outflows – a source of KRW under performance in recent years – persist. On the more positive side, the inclusion of South Korean government bonds in the FTSE Russell’s World Government Bond Index may result in fixed income inflows from November 2025, which would help cap dollar-won appreciation. More broadly, we do not expect the won to face a crisis given the country has a current account surplus, reasonable amount of foreign currency reserves and limited foreign currency borrowing. However, we clearly expect a weaker won against the USD in the months ahead.