The euro is strengthening slightly and risk premiums are being dampened on French bond yields, while the Paris stock exchange is turning upwards.
The market is cautiously positive after the weekend's election in France. However, many analysts are warning of a political deadlock and growing problems with already large budget deficits.
No party block has its own majority in the French parliament after the weekend's election.
"(President) Macron's economic reform agenda is dead," states The Wall Street Journal in an editorial.
Tough Left-Wing Demands
The main scenario on the market is now that there will be a period of political horse-trading in France. Emmanuel Macron's center alliance Ensemble – which became the second-largest block in parliament – is expected to have to adapt to the election's surprise: the left-wing alliance New People's Front (NFP), which unexpectedly received the most mandates.
The middle factions will thus face tough left-wing demands for a lower retirement age, reintroduced wealth tax, increased housing subsidies, and higher wages for public employees – measures that are estimated to cost 100-150 billion euros per year in 2025-2027. This will be pitted against their own pension and labor market reforms and planned budget austerity measures.
French public finances are already characterized by large deficits. The IMF has warned of several years of deficits exceeding the EU's ceiling, and the EU Commission has recently launched an investigation that could result in sanctions.
The market is also keeping an eye on the deficits in Paris. The risk premium on French government bonds compared to German ones has surged to the highest levels since the euro crisis days of 2012 over the summer – since Macron called for new elections on June 9. The euro has also been pressured. And the Paris stock exchange stood out as one of the few major stock exchanges in the world on minus since the turn of the year, before recovering somewhat last week.
Market Takes a Breath
But the market seems to be taking a breath now. The risks looked even greater before the election, and a left-center compromise is considered likely to be better for public finances than the more radical financial policy that could have resulted if NFP or Marine Le Pen's National Rally (RN) had gained a majority.
It is, however, expected to be very difficult to form a new government. And even more difficult to push through a political line with the deep divisions between the three major party blocks in parliament.
Analysts at the American megabank Citi describe it as "a parliament in deadlock, without any clear stable coalition, which is likely to pave the way for a prolonged period of political instability".
