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Market turbulence to rock France and Eurozone ahead of elections

Written by Patrick Barbe, European fixed income head and senior portfolio manager at Neuberger Berman

Midway through a record-breaking year for elections, we have just been given another – and it is potentially among the most important.

Four years ago, we greeted the arrival of the “Next Generation EU” funds as a key moment of solidarity for Europe – a package of pandemic-recovery measures that included, for the first time, fiscal transfers between European Union member states. Last week, the next stage of those measures was put in grave doubt.

 
 

Gains for hard right-wing and Eurosceptic parties in elections to the European Parliament did not help. But the major risk has come from President Emmanuel Macron’s decision to call a snap parliamentary election in France, after Marine Le Pen’s Rassemblement National (“National Rally,” RN) took first place in the country’s European elections, with 31.5% of the vote.

The euro has dropped by around 1%. French government bond spreads, already under scrutiny due to fiscal pressures and a rating downgrade, have widened to their highest level for five years, dragging Italian and Spanish spreads with them. The CAC 40 Index has fallen by 3%, with French bank stocks hit particularly hard. There has been a clear flight to quality, with German bonds outperforming.

These are not crisis-level moves, but they hint at how much hangs in the balance between now and the French elections on June 30 and July 7, and how the sentiment that has kept eurozone bond spreads tight over recent years is now under threat.

 

Disruptive

The composition of the European Parliament – which plays critical roles in setting the EU budget and deciding on legislation – has not swung as far to the hard and Eurosceptic right as opinion polls were suggesting two or three months ago.

Greens, social democratic and left-wing parties lost a substantial number of seats while hard-right and Eurosceptic parties added to their total. That said, the centre-right grouping added to both the number and proportion of its seats, and the hard-right coalition has become more fragmented after Germany’s Alternative für Deutschland (AfD) was expelled from one of the right-wing party groupings.

 
 

One of the Parliament’s first tasks is to vote for the President of the European Commission, a key role within the EU’s institutions. There is some speculation that right-wingers may seek to delay the appointment until there is clarity about the new alignment of power in France, but the politics are unusually complex and the current President, Ursula von der Leyen, is the candidate of the main centre-right party group, whose vote held up well in the election. Five years ago, she won a slim majority with the help of votes from centre-left party groups. This time, she has been courting votes from the right; it is likely to be another close call, but von der Leyen remains the favourite.

Opinion surveys, as well as the poor showing from Green parties, suggest that the European electorate is struggling with inflation and looking for a change of direction on issues such as the green transition, defence and security, and borders and immigration.

National governments and the EC have arguably already started to move on the second two issues, however, the Parliament’s new composition is unlikely, in itself, to disturb the major planks of the green transition – let alone threaten programs that are already in place.

 
 

Overall, we think the European Parliament will be less disruptive of the EU’s strategic direction than some commentators have been suggesting. On its own, this election result might not have caused investors much concern.

Mandate

However, EU governance requires the EU’s strategic direction to be ratified by the national parliaments before being implemented at European level.

 

The next iteration of broad EU strategy, following on from the Next Generation program, is likely to be determined by Mario Draghi’s report into European competitiveness, which is due to appear this month. It is expected to recommend deeper coordination to take better advantage of the EU’s scale, unblock industrial and supply-chain chokepoints, and secure the supply of essential resources.

These forthcoming reforms were already at risk because Macron has not commanded a majority in the French National Assembly for two years.

For example, splits in the centre-right Républicains party, in particular, led to the controversial passage of his key pension reform without an Assembly vote back in March 2023. Macron’s party has failed to build a coalition, and most of the other parties have started the battle to replace him in 2027. On top of that, the RN result in the European elections considerably weakened his government, making it likely that the opposition would take the opportunity to table bills aimed at overthrowing the government this autumn. President Macron dissolved the Assembly to keep his leadership and to surprise and destabilize the other parties. His strategy now appears to be to refresh his mandate by uniting a majority in the new Assembly against the hard right – at the expense of allowing the hard right to win more seats.

 
 

This is why we think Macron is taking a significant risk – not only with his own authority, but also additional risk with the Draghi reform program, some of which could be rejected if there is a major shift in the balance of power in the French National Assembly.

Should RN be able to form a parliamentary majority in July, however, it would be consequential not only for France, but for significant parts of the Draghi reform program. It could fall at its first hurdle long before it gets anywhere near the European Parliament itself; that, in turn, could undermine the foundations of the eurozone periphery’s recent economic and market strength.

Politics

 
 

The politics of this are complex and unpredictable. RN’s electoral success at the European level is no guarantee of similar success at the national level, where the stakes are perceived to be higher. Hard-right allies whose countries stand to benefit from deeper EU fiscal and market integration, especially Italy’s Prime Minister Georgia Meloni, could yet exert some influence over Le Pen. And history suggests that the EU is fine-tuned to salvage value out of a crisis.

But last week’s market reaction hints at what is at risk. As we wrote this, the G7 meetings hosted by Meloni in Italy were getting underway and may already have been the source of more market-moving headlines. The volatility and wider French and eurozone periphery spreads are likely to persist at least until the French elections in two weeks’ time – and potentially well beyond.

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