Yet more elections

This weekend sees the first round of the French parliamentary elections. President Macron called these elections in the wake of the poor performance of his coalition in the European Parliamentary elections. Support for the more extreme parties (according to opinion polls) – left and right – has raised investor concerns and pushed the cost of French government debt higher.

The two-round voting process makes it tough to make any confident predictions, but the right-wing National Rally party looks likely to emerge as the largest party. It might fall short of an absolute majority, making the precise composition of the government very unclear.

National Rally politicians have tried to give some reassurance to investors about their spending plans and their possible relationship with the European Union. But some of their proposals, like reducing the retirement age from 62 to 60 rather than raising it, will probably not sit well.

But the real point is that this additional election may serve as a reminder of France’s fiscal challenges, regardless of who wins. Let’s dig into that in a bit more detail.

The chart below shows the Gross Debt to GDP for Italy, France and Greece. As you might expect, France has the lowest debt to GDP of the three.

But if we look at the change in debt to GDP we see a different picture. The chart below shows the growth in debt to GDP over time. In this case, debt to GDP has risen most significantly in France, while Italy has stayed fairly flat over the past twenty-five years. And, the IMF forecasts that French debt to GDP will drift higher, while Greek debt to GDP, for instance, will fall quite sharply over the next few years.

When we look at primary balances, we see the impact of increased spending around COVID, but the IMF is expecting both Greece and Italy to run primary surpluses in the near future, while France is expected to remain in deficit.

Coming back to the cost of government debt. A lot of attention has focused on the difference between French and German government bond yields, which have widened (see chart below). 

But maybe we should also pay attention to the shrinking spread between France and Italy (see chart below). Given their relative fiscal positions, a tighter spread between French and Italian 10-year bonds doesn’t seem so strange.

Regardless of the outcome of these elections, we think that the spread between French and German debt might not tighten back to where it was. The increased focus on France’s fiscal outlook may be here to stay.