Euro weakens against the dollar amid political uncertainty in France

France's left wing parties hold sway in budgetary matters after winning seats

by Faruk Imamovic
SHARE
Euro weakens against the dollar amid political uncertainty in France
© Getty Images/Matt Cardy

Main Points

  • • Having won a plurality of National Assembly seats, the France's Left-wing parties may still have a say in France's budgetary matters and administration, once a multi-week period of political uncertainty gets resolved. The EUR's gains against the USD are limited, therefore. We like selling EUR/GBP on a medium-term view.
  • • The prospect of weak global growth (and Euro area growth) alongside weak US growth doesn't augur well for FX. There will be an element of flight capital toward the USD should a global weakening become the main investment theme in stocks, bonds, etc., and risk-taking.

France

It isn't surprising that the EUR/USD hasn't rallied following the final results of France's National Assembly election - indeed, it gapped lower at the Asia open last night. In the election, the populist-right (led by the National Rally) was beaten back by a semi-coordinated efforts of a coalition of centrists (President Emmanuel Macron's Ensemble coalition) and a coalition led by the far-Left (the New Popular Front, led by France Unbowed), which had removed their respective candidates from many races to avoid splitting the vote between the center and the Left. But the outcome of that "strategic maneuvering" has been a surprise 'win' for the Left, which will have a plurality of around 188 seats within the 577-seat National Assembly.

There are at least two main ways that the path to a government in France itself can now take. In the first, (1) appoints a prime minister from the NFP (presumably, from the Socialists or Greens), who would then lead a minority government of the Left, so long as there is enough consensus from enough Ensemble deputies to prevent immediate votes of no-confidence in a Left-wing government from succeeding. Macron's rationale might be let the Left make budgets and administer the government, and justify it simply by saying that the Left is the choice of the people. Also, he may do this to expressly allow the Left's administration to fail, thus allowing centrists to regain some power with the largest plurality in the next elections (2025, at the earliest). This scenario would be a negative for the EUR, because a Left-centered government would be a a fiscally expansive government, which could delay the budget's convergence to the -3%-of-GDP deficit target of the European Commission's mandate under the Growth & Stability Pact. The only caveat is that the Left would be constrained by the risk of a no-confidence vote in the future if it goes to far by enacting some of its most controversial items, as it loses support from centrists (and the populist-right).

In the second scenario (2), Macron and Ensemble would negotiate with the all or some of the deputies from the centre-left segments of the NFP (primarily, centrist Socialists or Greens) to split them off from the farther-Left Parties (primarily, France Unbowed and Communists) to form a center-led coalition. (That's possibly also with support from the center-right Republicans to secure a majority.) The combination of all of centrist Ensemble, all the Socialists, and all the Republicans could muster the requisite 289-seat majority. Although a center-led government (either in majority or minority) would be better than a Left-led government, it would not be "better" than what France had before the election, since it may require major concessions on fiscal policy from Ensemble to the Left, possibly including a revision of the pension reform, and probably also a prime minister from the Socialists, in order to reach an agreement.

Emmanuel Macron
Emmanuel Macron© Getty Images/Sean Gallup
 

Of course, the centrist Ensemble may first attempt, and then fail, to convince deputies from the Left to join them, thereby thereafter falling back to allowing a left-wing NFP-led minority government. But if they do succeed, that government may be unstable, due to the diversity of parties involved. But whether it is Scenario 1 or 2 that prevails, France could now go through several weeks or months of political uncertainty, during which it makes almost no progress toward addressing its wide budget deficit. It would make negative progress as the Left gains influence over the center. We recall that the policy agenda of the NFP is associated with budget deficits that approach -7% of GDP by 2027, vs. Macron's own -3% target.

We think that lingering uncertainty about France's fiscal path, general apathy around the prospect for Euro area growth, and lingering doubts about the political cohesiveness of the EU polity, both within EU countries and across EU countries, will continue. It's hard to see a EUR/USD rally past 1.08 that becomes durable in the medium term unless it is kept there by a general weakening of the USD. But that would only happen if the US economy slips more precipitously than the rest of the world's, and the Fed accelerates its easing and produces two rate cuts in 2024.

Against the uncertainty in France, the UK's new government may begin to improve the UK's ties to the EU (see here). That theme is a structural positive for the GBP vs. the EUR, even though GBP/USD has downside risks into the August 1 BoE policy meeting, where the Bank Rate could be cut. We're inclined to sell EUR/USD on a medium-term (3-month) view; the cross could sink back to 0.84.

US Economy

The US's economic activity surprise index has rolled over, driven lower by the weak ISM data for both manufacturing and services, with the employment sub-index in the services ISM down for five consecutive months, something typically associated with negative payroll growth. We have yet to see that develop, but private-sector hiring has slowed, especially when considering the revisions to April and May data in the June employment report last Friday. The Atlanta Fed's GDPNow tracker sees growth at 1.5% (s.a.a.r) in Q2, a big drop from the 4% estimated back in April. The St. Louis Fed's Nowcast is down to 0.7% - i.e., well below trend growth. The U-3 unemployment rate is now up 0.7 percentage points from the cyclical trough seen in January and April of 2023, and now exceeds the Fed's Q4 2024 projection (in the SEP) by 0.1%. No other time in post-war US history has a rise of 0.7% in the U-3 unemployment rate not been followed by a further rise. Of course, this is all taking shape against the backdrop of a persistent yield curve inversion. (Since the 1960s, no US business cycle recovery has endured beyond two years beyond an incipient inversion, and we are now at the two-year mark.)

The segments of US demand that are weakening in Q2 2024 (and, hence, driving the cycle downward) are consumer discretionary spending and housing. In the case of housing, one could surmise that high interest rates are finally taking their toll on demand. Notably, the NAHB Index has been low since 2023 began. But the drop in lumber prices tells a similar story. In the case of consumer discretionary spending, we blame also the depletion of pandemic-era excess savings at households. By the Philadelphia Fed's estimates, pandemic-era excess saving was projected to be depleted before mid-2024. It may not be a coincidence that US consumer spending has slowed significantly since late Q2 (here). (The caveat, of course, is that estimates of aggregate excess savings during the pandemic period are subject to error because they are highly sensitive to the methodology used and the assumptions made about the pre-pandemic trend.)

Ahead of the June US CPI report on Thursday, we expect that the tone of the major central banks - the Fed, ECB, BoE, and BoC - will be dovish in any forthcoming speeches and appearances. Jay Powell's 2-day testimony before committees of the Senate and House of Representatives starting tomorrow will be key central bank events this week, and we expect that Powell will follow the 'dovish' tone outlined in the Minutes of the June 12 FOMC meeting, which highlighted many elements of the slowdown in the US economic activity data in Q2. That tone could set the stage for the other central banks too, effectively negating any weakness for the USD that Powell will impart if he is dovish.

France
SHARE