How Macron's election gamble sowed panic in French markets

[June 15, 2024]  By Alun John and Harry Robertson

(Reuters) - French stocks and the euro have tumbled this week as political uncertainty in France and the possibility of a far-right-dominated parliament spook investors, while the gap between French and German government borrowing costs has soared.

Marine Le Pen's eurosceptic National Rally is leading in opinion polls following President Emmanuel Macron's surprise decision at the weekend to call a snap vote, while France's left-wing parties have formed a new alliance to fight the election.

The worry for markets is that a far-right French prime minister could pursue high-spending "France first" economic policies, adding to the country's large debt pile. Some investors have started to talk of the risk of the euro zone breaking up, although that remains a way off.

Here are four charts showing how markets have been reacting.

French stocks have sold off hard. The blue-chip CAC 40 is at its lowest since January, having shed 6% this week - its biggest weekly drop in over two years.

"There's an element of 'shoot first, ask questions later' with regards to France," said Tom O'Hara, a portfolio manager on the European equities team at Janus Henderson Investors.

"We're focused on global companies that are listed in Europe. Certainly, those that are more domestically exposed, there are going be more question marks about."

Midcaps, which typically have more exposure to the underlying national economy, are down 9%, the biggest weekly drop since March 2020's pandemic turmoil.

Banks have been particularly hard hit. BNP Paribas, Credit Agricole and Societe Generale are all down over 10% this week, losing roughly $19 billion in market cap since Friday's close, based on LSEG data.

French government bonds are also under pressure.

The difference between French and German 10-year borrowing costs rose to 78 basis points on Friday, the highest since 2017 on an intraday basis and on track for a closing level not seen since the euro zone crisis of 2012.

The spread reflects the premium investors demand to hold French government bonds rather than German bonds, the euro zone benchmark.

The wider spreads could provide a "tactical buying opportunity," said analysts at UBS, "but we expect investors to take a wait-and-see attitude until there is more clarity on electoral alliances, as well as fiscal policies in the case of a cohabitation - a situation where the prime minister and president are from different parties."

The Euronext stock exchange is pictured at the La Defense business district in Paris, France, September 30, 2022. REUTERS/Benoit Tessier/File Photo

It now costs the French government more to borrow money for 10 years than it does the Portuguese government for the first time since at least 2005, according to LSEG Datastream.

Spreads are also widening due to a general rush for safe haven assets in Europe and that includes German government bonds. The yield on German Bunds is down 24 bps and set for its biggest weekly drop since December.

"It is going to be a long month for the euro," said Chris Turner, global head of markets at ING.

The currency has dropped around 1% against the dollar, British pound and Swiss franc this week alone, and is at its lowest against the pound in almost two years.

Markets are braced for further sharp moves. One-month options volatility for the euro against both the dollar and the pound has jumped to its highest in over a year.

"With opinion polls taking such a toll on the euro and presumably more polls due this weekend, we expect investors will want to manage their euro exposure carefully," said Turner, who reckons the euro could drop towards $1.06 next week, which would be its lowest since November. It's currently at $1.0685.

The cost of insuring France's debt against default has also rocketed.

France's five-year credit default swap widened to 36 basis points (bps) on Friday, having been just 24 bps as of market close on 7 June, a week before.

These levels are the highest since the pandemic, and prior to that, since the 2017 presidential election, when markets feared Le Pen might be elected France's president.

(Reporting by Alun John and Harry Roberston; Additional reporting by Dhara Ranasinghe; Editing by Amanda Cooper and Christina Fincher)

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