France Elections Spark Worries of Market Turmoil. Is It the Next Greece?

More election-related surprises are roiling markets—this time in France, where President Emmanuel Macron called for snap elections.

French stocks and bonds were rocked over the weekend after Macron called for an election three years early, following a much stronger showing for Marine Le Pen’s far-right National Rally in European elections.

A win by the populist party could fuel increased spending, sparking concerns about a European debt and currency crisis. Meanwhile, a rushed coalition on the left vows to break with Macron as the elections, on June 30 and July 7, approach.

The iShares France ETF fell 4% to $37.43 on Friday, down 10% since the beginning of the month.

But the scope of the uncertainty was even more evident in the bond market. The gap between 10-year bond yields in France and Germany widened to 80 basis points—its highest point since the euro debt crisis in 2011—and investors expect further volatility.

In a note to clients, Gavekal Research founder Charles Gave pointed to a sharp decline in French bank shares and its debt situation as reasons investors shouldn’t dismiss the prospects of a currency and bond market crisis.

The country is sitting on a large budget and current-account deficit, faces debt sustainability issues, and needs to issue over 400 billion euro in debt over the next 12 months, according to Gave. But the chances of what Gave describes as a “euroskeptic populist right” government could make foreign investors less willing to buy French debt.

If France has to fund it domestically, interest rates are likely to rise, Gave says.

France’s debt profile resembles some of the countries the International Monetary Fund—the lender of last resort—typically has to help, Gave writes. But if Le Pen’s party wins, it may not care for the European Union, let alone international institutions such as the IMF.

And that could create Greece-like vibes in the market, with international institutions trying to bring France to reckon with its debt situation the way they it did with Greece in the early 2010s, Gave says.

“There is an appreciable chance of a massive financial and political crisis if France appears suddenly to be in play,” Gave writes.

Others, such as the economists at Capital Economics, aren’t yet ready to call for a market meltdown, though they, too, see trouble ahead.

In a note to clients, the economists warned the gap between French and German bonds could widen further to a new normal of about 100 basis points, or one percentage point, if the far-right looks likely to form a government in the election.

But Le Pen has also voiced concern about France’s debt sustainability and that could help avoid a market meltdown. Her party also has to show some semblance of fiscal caution to avoid scaring off moderate voters needed for a shot at the French presidency in three years.

The short stint of former U.K. Prime Minister Liz Truss, who sparked a market reaction with big plans for subsidies and tax cuts, could also keep spending plans in check.

Macron’s gamble on elections will be watched closely elsewhere—including in the U.K.—and will be reflected by investors demanding more to hold all sorts of EU assets. The bet is a second runoff could be enough to create a coalition to ward off Le Pen’s rise.

Neither situation looks that tantalizing for investors.

“France is moving toward one of two extreme political scenarios: a working majority in its National Assembly dominated by the populist right, or a left-wing majority that may include the radical left,” writes Thierry Wizman, Macquarie’s global interest rates and currency strategist.

With neither group ascribing to pro-market principles such as fiscal responsibility or single currency, volatility is likely ahead as investors demand more to own French and European assets. In a note to clients, Mark Dowding, BlueBay chief investment officer, said he was shifting toward longer duration German bonds in the event there is more of a flight to quality in the euro zone. The U.S. Dollar Index gained as the French political uncertainty created a risk-off sentiment and investors gravitated toward seemingly safer assets such as the Swiss Franc, Japanese Yen, and U.S. Dollar.Write to Reshma Kapadia at [email protected]