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A new political crisis in France, initiated by President Macron's decision to dissolve Parliament and call for early elections, has led to a resurgence of volatility in the credit market and a negative outlook for equities, especially for consumer-sensitive stocks and the defensive sector.

Is the Frexit syndrome back? The 10Y OAT-Bund spread has widened by 30bp to 70-75 bp since June 10th, reaching a peak at 76 bp on June 17th, the widest since 2017. This widening spread is close to the peak of February 2017, when the market was pricing a "Frexit" risk due to the potential outcome of presidential elections.

The uncertainty in the market reflects:

1) the fiscal policy outcome,
2) France's diplomatic position, and
3) a divided Parliament, leading to a lack of strong leadership for implementing reforms or fiscal policy.

The redenomination risk has decreased compared to 2017, indicating a lower risk of "Frexit." However, the fiscal risk has increased due to the sharp rise in the debt/GDP ratio following Covid-19 and government aid after the war in Ukraine, leading to downgrades in France's sovereign rating by rating agencies.

In this market insight, we present different political scenarios. As of now, the most likely election outcome will be a scenario consisting of three blocks with a relative majority for the new far-right-style (moderate) party.

Yet, given the budget constraints (limiting the room for fiscal impulse) and the labor participation rate which reached its highest value in 2022, meaning that the industrial capacity can’t go beyond its present capacity without further massive investments, the outlook for French equities is neutral to negative.

On the credit side, the higher political risk could have a spillover effect on other EGBs, with Italy being the most affected, while Spain and other core EGBs may benefit from this political risk.