Yield outlook: French politics do not alter the course

The political unrest in France has dominated movements in the bond markets since mid-June, which is likely, at least in part, due to the lack of a clear direction in economic data as well as central bank communication. As promised, the ECB lowered its policy rates by 0.25 percentage points at the June meeting, but the central bank also made it clear that the market should not necessarily see this as the start of a series of rate cuts. In the US, soft inflation figures for May slightly increased the likelihood of a rate cut in the fall, but the Federal Reserve (Fed) is rightly cautious about drawing too many conclusions based on a few data points. The market remains puzzled about the outlook for rates, and with solid growth and inflation risk on the upside, neither the ECB nor the Fed are in a hurry to provide any clarification. We expect tthe next rate cut from the ECB in December, while the first US cut is expected to occur in September.

French election unlikely to change the direction of the ECB or market rates

President Macron unexpectedly called for parliamentary snap elections to be held at the end of June/beginning of July following a significant defeat for the ruling party (Renaissance) in the EU parliamentary elections at the beginning of June. Since then, Scandinavian rates have declined significantly as investors sought the 'safe havens' in bond markets. The political concern centres around the non-establishment left/right parties, which in most polls are expected to gain significantly more influence in parliament. The fear of a more expansive fiscal agenda and ultimately a French EU exit ('Frexit') has been circulating in the media, but we assess that concern to be slightly exaggerated.

Admittedly, France is on an unsustainable fiscal course, and the country's budget deficit has consistently broken the applicable EU rules both before and after the pandemic, which is now starting to have consequences. The credit rating agency S&P downgraded France's rating from AA to AA- at the end of May, while the EU Commission included the country in a so-called 'Excessive Debt Procedure' in the middle of the month, which requires tightening of public finances. Other consequences could be sanctions. We assess that the risk of exclusion from EU/ECB support programmes will dampen ambitions of turning the fiscal policy substantially more expansionary, should the far right (Le Pen) or the left (Mélenchon) unexpectedly gain a majority. This conclusion aligns with the experiences from Italy, where Giorgia Meloni's 'Brothers of Italy' and the party's political agenda were groomed after the takeover of power in 2022. The market back then similarly feared a rollback of Draghi's growth-oriented reforms and budget disputes with the EU, but so far that concern has largely been unproven. Even for anti-establishment parties, the cost of a confrontational line with Brussels and markets has apparently become too great.

Download The Full Yield Outlook