France’s Snap Elections: Four Takeaways for French and EU Debt Markets

French politics have dealt the markets some big surprises in recent weeks. The snap-election victory of the New Popular Front – a left-wing coalition formed at the 11th hour to challenge the far-right National Rally – upended expectations that the right would prevail. But with no party claiming an outright majority, the potential for a hung Parliament (and resulting policy statis) actually calmed fixed income markets that had feared a more decisive win from either the left or the right in the lead-up to the elections.

More recently, President Emmanuel Macron secured an agreement between centrists and the center right to reelect Yaël Braun-Pivet as head of the French National Assembly, thereby taking steam from the left’s political momentum and creating room for a potential way out of the expected political gridlock.

Here we discuss four key takeaways for fixed income investors in France and the EU.

1. French government bond spreads will likely remain elevated.

Looking at market pricing, after President Emmanuel Macron announced the snap elections in early June, spreads on French 10-year government bonds (Obligations assimilables du Trésor, or OATs) widened from less than 50 basis points over German bunds to more than 80 basis points – a level not seen since the European sovereign debt crisis in 2012. As of this writing, French 10-year spreads have tightened but are still trading around 65 bps above bunds; for context, Spain’s 10-year is trading at around 76 bps over bunds, despite a three-notch rating differential with France (France is rated AA- by S&P and Fitch, while Spain is rated A by S&P and A- by Fitch).

We expect that over the next three to six months, French sovereign bonds will continue to move wider from bunds, and we would not be surprised to see OATs trading north of 70 basis points and even surpassing spreads for Spain. For this reason, we have favored an overweight to Spain (and even Italy, to a lesser degree) and an underweight to France. That said, from a market perspective, France sidestepped the two worst-case scenarios for markets: a truly decisive win by either the far left or the far right. This took some of the pressure off and helped to rein in spreads from the highs leading up to the elections.

2. France’s high debt-to-GDP ratio and fiscal deficit are unlikely to improve much, if at all.

France’s current debt-to-GDP ratio is roughly 110%, the third-highest level in the eurozone, exceeded only by Italy and Greece. More worrying is that between 2019 and 2023 – the period starting just before the onset of Covid and extending through last year – France’s debt increased the most rapidly of any EU nation, with about a 13% rise from below 100 in 2018. By comparison, Belgium and Spain, which are just behind France in terms of debt to GDP, saw their ratios increase between 7% to 10% over the same period.

French Debt/GDP Has Increased the Most Since 2019

Source: EuroStat, UniCredit Research

Moreover, France’s fiscal deficit was 5.5% in 2023, higher than the expected 4.9%. Macron’s government had anticipated a reduction in spending from the levels under the previous administration, with ultimate expectations of cutting the deficit to 2.9% by 2027, below the 3% target set by the EU for all member countries.

Looking ahead, with essentially a hung parliament in which no party enjoys a decisive majority, any government formed or prime minister elected is likely to be in a weak position, with little power to pass significant or controversial legislation. And with the left wing holding the most seats, we would not expect the deficit to improve, and could even see it worsen. All told, given the messy political playing field, we don’t foresee significant improvements in France’s deficit and overall debt position, which underscores our current negative sentiment on France and French risk in general.

3. France’s problems are France’s alone – at least for now.

The outcome of the recent elections did not trigger a big selloff or panic rippling out of France, and the political mess and resulting debt troubles remain idiosyncratic risks limited to the country. Contagion into Spain, Italy, and the rest of Europe could transpire if elections down the line do yield a worst-case scenario that causes upheaval in the markets, making the potential for a broader European crisis a reality. But at the moment, we see France’s problems as France’s alone.

4. Our fixed income positioning views remain less favorable for France.

Our outlook on French debt continues to skew more negative. We favor maintaining an underweight to French sovereign debt and take a cautious stance toward French credit, viewing Spain as the more attractive candidate and Italy also looking favorable. In the banking sector, we favor a cautious approach and neutral to underweight positions in French banks as we await better entry points.

Turning to currencies, we don’t see notable implications of France’s political situation on the euro. We currently favor the US dollar over the euro for the short to medium term, largely due to the expected rate differential based on our views on the number of rate cuts by the Federal Reserve versus the ECB. However, this preference is marginal. We think the euro will be trading in a range of 1.05 to 1.10 to the US dollar, and for the reason, we think it’s good to maintain an overweight to the dollar; however, the reasons for this have little to do with the situation in France.

We maintain our focus on careful bottom-up issuer selection and risk management in France and more broadly to opportunistically tap into the most compelling assets – and a nimble approach is key as geopolitical risks evolve.