French political risk is infecting global markets

Investors came into 2024 expecting that politics could be a big catalyst for stock markets this year. But they probably weren’t betting it would come from France.

The nation’s CAC 40 stock index is off 6.5% this week, its worst weekly showing since March 2022, following the aftermath of Russia’s invasion of Ukraine. The plunge erases all of its year-to-date gains. And the spread between German and French 10-year bond yields — a proxy for idiosyncratic risk in France debt — ballooned to its highest level since 2017, another time of political confusion.

President Emmanuel Macron called for a snap election after a poor showing by centrist parties in the European Parliament elections. Early polls suggest that the National Rally, which leans anti-immigration and euroskeptic, would likely win the most seats in the upcoming votes and may be able to pick up enough support from other conservative parties to form a working majority.

The French political center is facing challenges from both sides of the spectrum: progressive parties also put forward plans to undo most of Macron’s economic reform agenda and run afoul of the European Union’s rules on fiscal spending and debt.

“To be honest, it’s hard to ignore the parallels between our current situation and the time of the sovereign debt crisis, as there’s that familiar focus on election results, sovereign bond spreads and debt sustainability, coupled with no obvious sign about where things are headed next,” writes Deutsche Bank strategist Jim Reid. 

To be fair, there a couple of big differences from the days of 2011: Europeans are now generally more politically cohesive and optimistic about the economy, according to surveys performed by the European Commission. This would, all else equal, appear to reduce the likelihood of tail events like a “Frexit” — especially as the National Rally no longer campaigns on leaving the EU.

Nonetheless, the political turmoil in France now appears to be bleeding through to global markets. More cyclically-oriented pockets of the market are for sale — Industrials, materials, consumer discretionary, financials, and energy US sector ETFs are off 0.5% or more in the first half-hour of trading on Friday, as is the more defensive utilities sector.

Also early in Friday trading, a Goldman Sachs basket of US companies with high sales exposure to Western Europe was trailing the S&P 500 by 1% on the day, one of its worst days of relative performance so far this year.

Weren’t we all looking forward to a slow summer Friday to watch some soccer?