Markets bet on French gridlock

A look at the day ahead in U.S. and global markets from Mike Dolan

An event-packed but shortened week stateside kicks off the second half of 2024, with European markets rallying on Monday as the first round of French assembly elections points to a hung parliament and policy gridlock.

Although French far-right coalition parties got the largest share of the vote at Sunday’s first round as expected, the percentage was shy of last-minute opinion polls and the grouping looks short of an overall majority when the process is over.

In part due to the high turnout, next Sunday’s second phase of voting will see more than half the parliamentary seats contested by three candidates – which means tactical voting to shut out the far right will likely affect their overall tally.

That suggests an outcome of messy parliamentary maths that stymies significant policy initiatives, not to mention another three years of “co-habitation” with the powerful presidency.

Viewed against “worst case” concerns of a wave of unfunded tax cuts from the former National Front and its allies, not to mention tense battles with Brussels, investors breathed a partial sigh of relief that it all looks muddier than that.

The benchmark CAC40 French stock index (.FCHI), jumped more than 2% on Monday – clawing back losses seen since the snap election announcement almost a month ago and returning to positive territory for the year to date.

The risk premium on French 10-year government bonds over German equivalents fell back to as low as 72 basis points, from 12-year peaks of about 85bp on Friday.

The euro jumped more than half a cent against the dollar, to its best levels in more than two weeks.

That’s knocked the dollar back across the board – with the French results perhaps delaying the reaction to the soft U.S. PCE inflation report for May.

This saw U.S. core inflation come in at slightly less than the 0.1% expected for the month, and the annual core rate drop to 2.6% for the first time in three years.

German states’ inflation numbers for June point to further easing of national price pressures too.

Still, Federal Reserve officials seem in no mind to take one month’s return to disinflation at face value and several have insisted they need to see months of such data to be convinced it’s safe to cut interest rates.

The European Central Bank has already reduced rates this year and looks set to act at least one more time before the Fed makes its first move.

ECB President Christine Lagarde speaks at the bank’s annual forum in Sintra, Portugal later on Monday and will be joined by Fed chair Jerome Powell there on Tuesday.

A hawkish message was sent by the Bank for International Settlements on Sunday, warning that rising government debt levels amid a number of major elections this year could roil global financial markets.

“They (governments) must cut short the rise in public debt and accept that interest rates may not return to the pre-pandemic ultra low levels,” he said. “We need a solid foundation to build upon,” said BIS General Manager Agustin Carstens.

Otherwise, the U.S. week is broken up by the Independence Day holiday on Thursday but is packed with big labor market data – some of which is frontloaded a day early because of the holiday. The JOLTs job openings release is due on Tuesday, for example, and the weekly jobless report on Wednesday – but the national payrolls report will be on Friday as usual.

Elsewhere, the UK holds its general election while the U.S. is away on Thursday.

Sterling and UK stocks (.FTSE), opens new tab were firmer on Monday, with opinion polls still pointing to a huge majority of more than 200 seats for the opposition Labour Party.

Japan’s yen , meantime, continued to flirt with 38-year lows above 161 per dollar – with no sign yet of any official intervention.

U.S. stock futures and bond yields were higher ahead of Monday’s open.

Key developments that should provide more direction to U.S. markets later on Monday:

* US June manufacturing surveys from ISM and S&P Global

* New York Federal Reserve President John Williams speaks; European Central Bank President Christine Lagarde speaks at ECB’s annual forum in Sintra, Portugal

* US Treasury sells 3-, 6-month bills

Source: Reuters