The influence of politics and policy on stock and bond markets is significant, yet often subtle due to its gradual impact. Financial media tends to focus more on monetary policy, and for good reason: interest rate changes have immediate effects on everything from mortgages to deposit rates and asset prices. In contrast, fiscal policy—whether tax policy or fiscal stimulus—is harder to measure, can take years to take effect, and may produce unpredictable or unintended outcomes. For instance, few anticipated that the post-COVID stimulus in the US would lead to nearly double-digit inflation.
In democracies, fiscal policies tend to last only as long as one party is in power and can vary sometimes radically from election to election, depending on who gets into office. Elections also create uncertainty, which markets loathe. With the upcoming election in the US, we thought it would be interesting to look at how markets in the UK and France have digested two recent snap elections as a preview of what may lie ahead.
The first thing to keep in mind is that the UK and France are obviously not the US. Both have multiparty parliamentary systems with different systems for choosing leaders and legislators, which we won't delve into for brevity. They are also closer to social democracies than the US, with nationalized healthcare and generally closer links between corporations and government.
By American standards, the European political spectrum is broader and doesn't directly correspond to the US two-party system. Most of the French left is considerably more socialist than the Democratic Party. The French Right shares commonalities with Trump's nationalist populism. Both countries also have more centrist parties and even Communist parties, offering a wider range of electoral choices.
Let's start with what happened recently in France. Macron, the French President, shocked markets on June 9th by calling for a snap election, sending French stocks lower and French bond yields higher. The three main parties competing for legislative votes were Macron's centrist Ensemble coalition, a left-wing coalition called the New Popular Front (NFP), and the far-right Rassemblement National (RN). In the first round on June 30th, the right-wing RN group were the winners, edging out the NFP and the Macron group, which came in third. The market uncertainty between the surprise announcement of an election and the first round of voting led to a 6% decline in French stocks and a huge 25 basis point increase in 10-year bond yields.
After the first round of votes, bond yields declined and stocks rallied going into the second round of voting. In the second round, after the left and center parties worked not to compete in certain districts, the possibility of an outright far-right victory was thwarted, with the French left emerging with the most parliamentary seats, but not the clear majority needed to rule.
Whatever legislative outcomes happen in France now will require one of the three competing groups to work together and form coalitions, which will take time. No one wins. We don't have much pricing since the second-round elections, but the gridlock guarantees it will be hard for any group to implement radical fiscal policies going forward, which probably provides the stability that markets prefer.
In contrast, UK market reactions to both the call for a snap election and the election itself have been more subdued. This is likely because a Left or Right victory in the UK typically produces less extreme outcomes, as the Labour and Conservative parties are comparatively closer to the political center than their French counterparts. For context, the Conservative Party has been in power for 14 years, with different Prime Ministers taking the helm, each with sometimes very different priorities.
As shown in the first chart below, the May 10th announcement of UK elections led to a 3% sell-off in stocks, though equities remained range-bound thereafter leading up to the July 5th election. Ten-year Gilt yields also rose about 25 basis points but ultimately settled close to their starting point. Both have been moving sideways since it was announced that Labour would form a new government.
Unlike the French market reaction, which led to sustained sell-offs, the UK reaction to the uncertainty of election results was relatively brief and less extreme. The only market that showed sustained strength over the entire period was the British Pound, which rose 3.5% against the US dollar both leading up to the election and after the vote.
Given the events in Europe, we can draw several lessons for the upcoming US election in November. In France, we observed markets digesting the possibility of a radical shift in fiscal policy, either to the left or right, ultimately resulting in gridlock. The UK saw a shift in political priorities towards the left.
In the US context, should Trump and the Republicans win majorities in both houses of Congress, fiscal policy would likely shift dramatically from that of the Biden administration. Trump has promised less regulation, greater import tariffs, and various tax cuts.
How US and global markets will fully interpret this potential fiscal policy shift remains to be seen. However, we can anticipate that, as in France and the United Kingdom, uncertainty will drive greater market volatility leading up to November. Investors should mentally prepare for increased market turbulence in the months ahead.
Data Source: Bloomberg
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