Markets between politics and fundamentals

French politics over fundamentals
As expected, the right-wing Rassemblement National (RN) won the first round of the French parliamentary election on 30 June. They came ahead of the left-wing alliance of the Nouveau Front Populaire (NFP), relegating president Macron’s centrist coalition to third place. However, the outcome of the second round on 7 July remains highly uncertain. According to current projections, the RN still falls short of the 289-seat absolute majority. That said, at the time of writing, the centrist and left parties are still deciding whether to pull candidates out of hundreds of run-offs where three candidates are involved to block the RN from power with a potential absolute majority. The deadline for candidates to submit their applications is Tuesday 6pm CET, when the picture may get a bit clearer. However, tactical voting could be less pronounced than in previous elections. In our view, the three main scenarios we outlined here remain. The options are (with probabilities ranging from higher to lower): a hung parliament, an absolute majority for the RN, and an absolute majority for the NFP. All three scenarios would mark a change after years of pro-economic-growth reforms implemented by Macron. 

Given the (moderate) fiscal risks and a more fraught relationship with the EU, as of early on Monday morning, the market seems to be relieved by the prospect of the hung parliament rather than an absolute majority from either the right-wing or left-wing party. French stocks and government bonds were under pressure last week ahead of the vote but responded positively on Monday morning. The CAC 40 index and the euro rebounded, while the spread between French and German government bonds narrowed but remains well above levels before the announcement of the snap elections. We think French government bonds remain the most exposed to unfolding events. French stocks could underperform their European peers under all three scenarios mentioned above, while the euro will be driven more by fundamentals. Although French and European stocks are on levels that could be judged ‘attractive’, we think it’s still too early to add these markets until uncertainty clears somewhat. We are currently holding slightly fewer European equities relative to our long-term allocation.

US fundamentals over politics
Markets were relatively quiet during most of last week, ahead of the release of the US inflation figures. Inflation came in as expected at 2.6% for both headline and core (excluding volatile items such as energy and food prices). The data will probably ease some of the US Federal Reserve’s (Fed’s) concerns that inflation will remain above the 2% target for longer. While we believe that will probably be the case, the cooling of inflation below 3% is a positive signal for the Fed. However, it probably needs to see a little more data (see below) to go ahead with a first rate cut. We think September could be the time when the Fed starts cutting. Last week also saw the first presidential debate between Biden and Trump, although markets didn’t seem to react to this. The second debate is scheduled for September when we think the presidential race will step up a gear, but a lot could happen before then. Especially if one of the candidates were to be deemed unfit for office. Overall, despite trading relatively sideways most of last week, US equities closed the week slightly higher, but the lack of downside surprises from the inflation data pushed US Treasury yields a little higher, while the US dollar was flat.

A busy week
Monetary policy expectations will continue to take centre stage in the US. The minutes of the previous Fed meeting, and several reports on the job market and economic activity could be key market movers. The labour market is expected to show some signs of cooling, which could help markets cement the case for a September rate cut from the Fed. On the other side of the Atlantic, in between the two rounds of the French elections, European market watchers will have their eyes on Tuesday’s inflation data, which economists expect to have slowed down a notch. With the Fed increasingly likely to cut rates for a first time in September, we believe the European Central Bank (ECB) will cut rates in September as well. Provided inflation doesn’t reaccelerate towards year-end, which is not our base case, the ECB could also cut rates for a third time in December.