French election triggers market panic, echoing the British budget disaster?

According to the Zhitong Finance and Economics APP, as the French parliamentary elections approach, the strong momentum of the far-right and left-wing parties has raised concerns in the market about the budget crisis in the core areas of the Eurozone. French President Emmanuel Macron announced that the elections will be held from June 30 to July 7, with the far-right National Rally party (RN) led by Marine Le Pen leading in pre-election polls, although unlikely to win an absolute majority. Previously, the National Assembly advocated lowering the retirement age, reducing taxes, and increasing spending.

It is understood that just a few weeks ago, France's high deficit led to a credit rating downgrade, exacerbating concerns about the fiscal sustainability of the Eurozone's second-largest economy.

Meanwhile, the newly formed Left Alliance stated last Friday that they hope to lower the retirement age and link wages to inflation, increasing expectations for increased government spending. Opinion polls show that the support for the left-wing party is second only to the National Party.

Investors have reacted tepidly to this situation. Data from the London Stock Exchange shows that investors' risk premium for French government bonds relative to German bonds rose to its highest level since 2017 last Friday, at 82 basis points, the largest weekly increase since 2010. Although the market calmed down on Monday, with rates falling to 75 basis points, they were still more than 25 basis points higher than before the election announcement.

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Gordon Shannon, portfolio manager at TwentyFour Asset Management, pointed out that the market focus has shifted to the possibility of a short-term crisis. He likened it to investors pricing in the risk of a similar event to the UK's mini-budget crisis, referring to the unfunded tax cut plan introduced by then-UK Prime Minister Liz Truss in 2022, which severely impacted the UK government bond market.

French Finance Minister Bruno Le Maire called on voters last Friday to support Macron's centrist candidate and warned that if the far-right or left-wing wins the election, it could trigger a financial crisis. Meanwhile, the cost of French debt default insurance soared to its highest level since May 2020, rising borrowing costs impacting the banking sector, leading to a sharp decline in the stocks of the country's three major banks.

However, European Central Bank Chief Economist Philip Lane stated on Monday that the current market trends have not reached a level of chaos that would require intervention by the European Central Bank. He emphasized that the European Central Bank would only consider intervening through bond purchases when the market is in turmoil.

Internal sources at the European Central Bank also revealed that policymakers are not currently planning to discuss emergency purchases of French bonds and believe that the current market reaction is more due to investor panic than a signal of an actual crisis. If action is needed, the European Central Bank will follow parameters such as EU fiscal rules to decide whether to purchase government bonds to limit budget deficits

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Political Turmoil in France Triggers Fiscal Alarm in Eurozone

Market turbulence has already affected France's financing plans, with a government-supported institution canceling a bond issuance and the Treasury Department reducing the funds raised in this week's bond auction, reflecting that market turbulence has begun to impact financing plans. Bond investors, referred to as "obligation police" by analysts, are demanding the government to be more cautious financially and are seeking higher returns for it.

Guillermo Felices, Global Investment Strategist for Fixed Income at PGIM, pointed out that the UK's mini-budget and the US Treasury's refinancing plan have undergone stress tests, but the Eurozone has not faced a similar situation yet. According to Montaigne Institute think tank analysis, if the National Rally party's plan is fully implemented, it will lead to a 3.5 percentage point increase in France's budget deficit, costing over 100 billion euros, far exceeding expectations.

National Rally party leader Jordan Bardella stated that the party will elaborate on its manifesto and funding sources in the coming days. Currently, the party's position on fiscal responsibility is not clear, only criticizing the outgoing government for causing public financial tension.

Holger Schmieding, Chief Economist at Berenberg Bank, warned that in extreme cases, risks may include a spike in spreads like that of Liz Truss. During the UK budget crisis, the 10-year government bond yield surged over 100 basis points in less than a week.

Some analysts are concerned that France's worries may spread to the entire Eurozone. Italy's risk premium relative to Germany has risen to its highest level since February, reaching 159 basis points, and Italy had the highest budget deficit as a percentage of GDP in the EU last year, at 7.4%. Italy is expected to face an excessive deficit procedure from the EU, requiring it to reduce its structural deficit. The euro to dollar exchange rate and Eurozone bank stocks have also declined.

However, some believe that potential governments, including the National Rally, may take a more cautious fiscal stance during their tenure. Last year, Italy performed well in debt under the leadership of far-right Prime Minister Georgia Meloni.

Ian Staley, Chief Investment Officer for International Fixed Income at J.P. Morgan Asset Management, stated that the United Kingdom's spending plans will be constrained by EU deficit rules. He added that the market will also be a key force in controlling the rise of the National Rally, which may adopt a more cautious fiscal stance before the 2027 presidential election.

Overall, while current market concerns about the political situation in France are escalating, the stability of the Eurozone and the fiscal discipline of its member states will remain key factors. Investors and market analysts will continue to closely monitor the political and economic dynamics in France and other Eurozone countries to assess potential risks and opportunities