Macron's Snap Election Call Sparks Market Turmoil

Key Takeaway

• Macron's call for early parliamentary elections has spooked financial markets, with the CAC 40 index dropping 2.4% and the euro weakening by 0.5%.
• France's fiscal concerns are mounting, with a budget deficit of 5.5% of GDP leading to credit downgrades from Fitch and S&P.
• Investor sentiment is shaky as French bond yields widen against German counterparts, reflecting fears of political and fiscal instability ahead of the elections.

Macron's Snap Election Gamble

French President Emmanuel Macron has called for early parliamentary elections, a move that has introduced significant political uncertainty and has been met with apprehension by financial markets. The decision comes after a defeat in the European Parliament elections, where Macron's Renaissance party garnered only 15% of the vote, trailing behind Marine Le Pen's National Rally, which secured 31%. The elections will take place over two rounds, beginning on June 30 and concluding on July 7.

Financial markets have reacted negatively to the announcement. The gap between 10-year French yields and their German counterparts climbed to the highest this year, reflecting investor concerns about France's fiscal direction. "Investors don’t share Macron’s risk appetite," said Stefan Koopman, senior macro strategist at Rabobank. The euro weakened by around 0.5% against the dollar, and the French stock market underperformed its European peers, with the CAC 40 equity index in Paris slumping as much as 2.4%.

Fiscal Concerns and Credit Downgrades

France's fiscal position has been deteriorating, with the annual budget-deficit ratio rising to 5.5% of GDP last year. This has led to twin downgrades of the nation's credit rating to AA minus by Fitch Ratings and S&P Global Ratings. S&P projects that France's budget deficit will remain above 3% by 2027, with overall debt continuing to rise. The European Commission forecasts only a slight improvement to 5.3% for 2024.

UBS AG Group analysts believe it is highly likely that the European Commission will recommend placing France in an Excessive Deficit Procedure, which would require the country to reduce its deficit by at least 0.5 percentage points annually. This would necessitate a multi-year fiscal structural plan by late September, a prospect that is unlikely to sit well with investors. "The deficit picture in France is already weak and this would further add to market concerns," said Mohit Kumar, chief economist and strategist for Europe at Jefferies.

Market Reactions and Investor Sentiment

The financial markets have been on edge for months due to France's growing debt load and attempts to rein in spending and borrowing. The scope of Monday’s market tailspin suggests that financial assets could face more pressure in the coming weeks ahead of the election. French bonds dropped at the open, with the yield spread against Germany widening to more than 52 basis points, the highest since mid-April. "Traders have been swift to affix a political risk premium to euro-zone assets in the aftermath of the weekend parliamentary elections," said Ven Ram, a cross-asset strategist for MLIV in Dubai.

Despite the turmoil, there is no immediate funding issue for France. The French Treasury is over halfway to meeting its 2024 debt issuance target of €314 billion ($340 billion), with investor demand remaining healthy. However, the possibility of a repeat of the 2017 bond market wobble seen in the lead-up to Macron’s first presidential term win is not unthinkable. "Tolerance has its limits, and the harsh experiences of the euro crisis more than a decade ago illustrated how toxic political uncertainty can be," noted market observers.

Street Views

• Stefan Koopman, Rabobank (Bearish on French political risk):

  "Investors don’t share Macron’s risk appetite. His courage is undeniable, we’d give him that, but it seems like doubling down on a bet after a poor performance."