Rising Political Uncertainty Pressures CAC 40 Performance
With the French political environment becoming increasingly uncertain each passing day, confidence in the economy continues to decline as the upcoming election approaches. In a high-profile election year fraught with misconduct and growing anger among the populace, France could well be in for a surprise when the votes are tallied in April. The sweeping nature of anti-EU sentiment combined with populist rhetoric has seen far-right political party the National Front taking a significant lead in the polls.
The National Front, led by Marine Le Pen, has found a message that really resonates with voters, especially after the significant shift in political attitudes witnessed over the last year. A spate of terrorist attacks combined with more tepid momentum for economic activity have combined to overwhelm the incumbent Socialist Party under the stewardship of Francois Hollande. With the “leave” rhetoric ramping higher and ordinary French citizens increasingly insecure about the country’s prospects, financial markets are likely to increasingly reflect this attitude.
Political Swing Reflects Growing Economic Uncertainty
When British voters came out to the polls for the exit referendum held over the summer, no one wanted to believe that the same sentiment was coursing through the veins of mainland Europe. However, as events since have shown, anti-EU sentiment is growing throughout the political bloc. As one of the key tenants of her candidacy, Le Pen has repeatedly called for an exit from both the political and economic blocs. While not all of France’s economic woes can necessarily be attributed to policies of the bloc and the current government, neither of these institutions have helped solved the underlying problems that continue to plague the country.
Extremely accommodative monetary policy from the European Central Bank has helped ease financial conditions greatly, but the problem has been the lack of accompanying fiscal stimulus and structural adjustments. France remains among the less competitive European countries thanks to draconian labor laws and myriad failures from the current Socialist government. One of the first mistakes that clearly spelled their demise was the decision to tax top earners by 75.00%. Although the measure was eventually rejected by the nation’s highest court, the damage was already done. Wealthy earners left the country in droves, fearing that their hard work would be effectively for naught.
With business owners shying away from hiring, the obvious reaction was dented business confidence. Even when taking up unpopular measures to making firing employees easier over the last two years, the extreme resistance caused even greater damage to the Socialist party’s image. As such, they are not being taken as serious contenders in the upcoming election. More importantly, the scandal that has brought down Republican candidate Francois Fillon has paved the way for Le Pen to win the first round of voting.As a result, the fix is in for more political uncertainty over the coming months and years irrespective of the election outcome.
Political Indecision Holds the Economy Hostage
Although polling has shown that she would lose in the second round to independent Emmanuel Macron, the prominence of Le Pen’s National Front in any upcoming government could undermine economic activity further.More is needed to reform the French economy despite the most recent set of gains in inflation and employment. Nevertheless, joblessness stands at 10.00%, above the comparable Euro Area figure of 9.60%, while inflation is outpacing gains in annualized GDP growth, further testament to the growing imbalances in the economy.Without real and serious reform, all the modest gains witnessed over the last year may rapidly be unwound.
The French CAC 40, a leading indicator of economic health, continues to reflect the fact that the only backstop for the country’s leading companies is easy monetary policy.Interest rates at record lows combined with asset purchases driving financing costs lower are highly supportive of equity prices, with even ECB President Mario Draghi reiterating on Monday that valuations are not overextended. However, it begs the question of what performance would look like without the Central Bank’s training wheels. With investors already selling French bonds as the political future of the country becomes more fragile, equities are likely to react negatively to any shred of evidence that sovereign risk is growing.
Widening Spreads Could Pressure CAC Lower
At present, the spread between German and comparable French bond yields continues to widen, indicating the investors are receiving higher yields for the added risk of holding French OATS instead of German Bunds. However, it should be noted that yields are rising for Europe across the board as political uncertainty prevails.Should Le Pen gain traction in the polls, it could worsen the outlook for French debt. Generally, any decline in bond prices and increase in yields will cause a negative reaction in local equities, placing added downward pressure on the CAC 40 over the near-term. With no end in sight for the structural deficiencies that need to be fixed alongside an increasingly Euro-skeptic push in government, the French CAC may not be able to shake the election risk stigma for some time.
Disclosure: None.