CONTRIBUTORS
David Zahn, CFA, FRM
Head of European Fixed Income,
Portfolio Manager
United Kingdom
French government bond spreads have unsurprisingly signalled a degree of relief following the first round of voting in the French elections on Sunday, with markets responding positively to the fact that the left-wing Nouveau Front Populaire’s share of the vote, while sizeable, was not enormous and not a majority. However, the story is far from over yet. Looking ahead to the second round of voting on July 7, it also seems improbable that Marine Le Pen’s Rassemblement National (RN) party will achieve a majority, meaning that investors will likely be contending with a hung parliament and continued political unease in France for the foreseeable future.
Getting the deficit under control in France is a major challenge and a necessary priority for the next French administration, but doing so without a parliamentary majority will be especially difficult. Both the right and left have sizeable spending plans, which is at odds with the goal of bringing down the deficit. It is also conceivable that parliament could be collapsed again in a year’s time in another attempt to achieve a workable majority.
The RN has expressed a willingness to respect the European Union’s fiscal rules, perhaps seeking to emulate the success of Italy’s Giorgia Meloni, who has generally become more market-friendly since taking office. However, seeking to reduce the deficit and achieving this in practice are two very different things, and investors are right to remain cautious in their optimism.
As investors, we believe caution in regard to French government bonds remains sensible. We expect to see continued volatility, not only over the coming week, but over the coming year, with continued political instability representing the biggest known risk to French markets. We would anticipate French government bond spreads to remain wide for the foreseeable future and believe that the current spreads represent a new normal.
While it is conceivable that there could be some tightening in the months ahead, investors will have to adapt to trading on wider spreads in the long term, whatever the outcome of this election.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.