The Perfect Storm: France Faces Dual Market Sell-off

Jun 15, 2024By Richie Li

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France is currently experiencing a financial storm, with both its stock and bond markets facing significant pressure. The CAC 40 Index dropped by 2.66%, closing at 7503.27 points, marking a 6.23% decline for the week and wiping out $210 billion in market value, nearly erasing this year’s gains. Concurrently, traditionally viewed as an alternative to German Bunds, French government bonds are undergoing a repricing wave. Amid large-scale sell-offs, the 10-year French government bond yield surged to 3.3320% mid-week before retreating slightly. Nevertheless, rising risk aversion has pushed the French-German 10-year bond yield spread to its highest level since 2017, with the week's increase setting a new single-week record.

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Right-Wing Surge Sparks Market Jitters

Last weekend, President Macron's party suffered a severe defeat in the European Parliament elections, while the far-right National Rally achieved an unprecedented lead. The following day, Macron announced the dissolution of the National Assembly and called for early parliamentary elections, a move widely perceived as a high-stakes gamble. Should the National Rally secure a majority, the installation of a right-wing prime minister would undoubtedly trigger a significant political upheaval.

The ensuing week was marked by market turbulence. The CAC 40 experienced its worst week since March 2022, with the plunge in stock prices threatening France's status as Europe's largest stock market. The French market's decline also dragged down the broader European STOXX 600 Index, which fell by 0.97% on Friday to 511.05 points, breaching its 50-day moving average and posting a 2.39% weekly loss. Major indices across the Eurozone followed suit, ending the week in the red.

Bank Stocks Hit Hard

Amid the broader market sell-off, bank stocks bore the brunt of the decline. Shares of France's three largest banks—BNP Paribas, Crédit Agricole, and Société Générale—plummeted by 12% to 16%, marking their steepest declines since the banking crisis in March 2023. Italian bank stocks also took a hit, with the FTSE Italia All-Share Banks Index dropping 3.73% on Friday and 8.99% for the week.

Bond Market Repricing

The uncertainty surrounding France's fiscal outlook has led to a sell-off in French and Southern European government bonds. The decline in bank stocks reflects the devaluation of their holdings of European sovereign bonds and rising credit risk across the continent, leading the market downturn.

Over the past week, the risk pricing in the French bond market has been escalating. On Friday, the yield spread between French and German 10-year government bonds widened to over 80 basis points. Political turmoil has spurred panic-buying of safe-haven German Bunds, while fears persist that should the right and left wings gain greater influence in the French parliament, their proposed expansionary policies could further exacerbate the already alarming fiscal deficit, potentially triggering a debt crisis reminiscent of the UK under former Prime Minister Liz Truss.

Fiscal and Economic Concerns

Marine Le Pen's National Rally has called for lowering the retirement age, cutting electricity and gas VAT, and increasing public spending. This week, French Finance Minister Bruno Le Maire warned that if the far-right wins the upcoming parliamentary elections, France faces the risk of a financial crisis.

The potential debt crisis has reinforced bearish market sentiment. Iain Stealey, Chief Investment Officer for International Fixed Income at JPMorgan, stated, "These events have solidified our negative outlook on France. We will not establish positions at current market levels until the election results are clearer."

Conclusion

Looking ahead, while the European capital markets may find support from central bank rate cuts and an economic recovery, France's market is likely to remain under the shadow of debt crisis and political instability at least until the parliamentary elections in July. Investors should brace for continued volatility and carefully assess the evolving political landscape as it unfolds.