| While America took time off to eat turkey, France has been cooking up a black swan. The political melodrama has stretched out for six months, ever since dreadful European election results prompted President Emmanuel Macron to call snap legislative elections. It didn’t work. Much chicanery produced centrist and left-wing tactical alliances designed to thwart Marine Le Pen’s National Rally from taking a majority of seats, thus producing an unworkable parliament divided into three roughly equal blocs — Le Pen and Macron’s groups, plus an ungainly left-wing coalition. It took Macron until September to appoint a prime minister, the center-right technocrat Michel Barnier. He’s spent three months trying to come up with a budget that will gain a majority and start to reel in France’s worryingly indebted finances. Le Pen is now aiming to show that she holds the power in this situation, and set Barnier a deadline of today to concede on a range of “red lines,” perhaps most importantly reversing a plan to raise pensions by less than inflation. The latest news at the time of writing is that Le Pen says the government refuses to negotiate further, and that she will not support the budget “unless there is a spectacular turnaround by the prime minister.” She will, however, happily support a vote of no-confidence in his government that could happen as early as Wednesday. That would force Macron to find a new premier. Elections aren’t possible until next summer, so neither is a new parliamentary makeup that would make this any easier. For its part, the government has accused Le Pen of blackmail. The Polymarket prediction market, which grew famous during the US election campaign, currently puts Barnier’s odds of surviving the year at 45%.  Moment of truth for Barnier. Photographer: Andrea Savorani Neri/NurPhoto/Getty Images It’s possible that Le Pen is bluffing, and will want to avoid being painted as the person who brought on a crisis — but after six months of the Keystone Cops show where the political forces arrayed against her have tried and failed to get their act together, she might take that risk. The stock markets’ view of all this is clear enough. French stocks started to dramatically underperform the rest of Europe once Macron called the election, and they’ve taken a further leg down over the latest brinkmanship:  A successful no-confidence vote against Barnier would compound that damage. But it’s the bond market that matters most. French bonds now yield more than those of Spain, meaning that investors think they need to be compensated for extra risk to lend to France. That is embarrassing for Macron. Truly humiliating is the fact that the gap between French and Greek yields has now been eliminated. Briefly last week, French bonds actually yielded more. The reversal of fortune since the euro zone’s sovereign debt crisis appears total: Using Germany as a yardstick, the extra yields on French OATS are now back almost exactly to when the then-president of the European Central Bank, Mario Draghi, famously promised to do “whatever it takes” to save the euro in 2012. To be clear, French spreads are still far tighter than during the worst of that crisis, and much narrower than Greek or Spanish spreads at the time. Defaults and bailouts are not in question. But France has a far bigger economy, and the Franco-German axis remains at the heart of the EU. It looks unlikely to set a budget within the agreed euro-zone parameters, and so the issue casts doubt on the currency area’s viability: All of this could be extremely unhealthy for the euro, which had a difficult but not disastrous start to Asian trading, dropping about 0.5% against the dollar. Deutsche Bank AG’s foreign exchange strategist George Saravelos argues: From a market perspective, a government collapse is arguably the worst outcome — it would essentially mean there is a lame duck administration for the next six months, the budget implications are unclear. Theoretically it means last year’s budget would be rolled in to this year, but this has never been done before to my knowledge.
Rolling over the budget would imply a further increase in France’s debt as a share of gross domestic product. If borrowing costs balloon further — likely if the government falls — the ECB might buy French bonds to help, but Barclays argues that it’s unlikely to do so because of requirements that French public debt be on a sustainable path. It could, however, act to rein in any contagion to other countries’ bonds.  A protest against Macron and Barnier. Photographer: Dimitar Dilkoff/AFP/Getty Images That suggests a future for French OATS to trade much as bonds of the peripheral countries did from 2010 to 2013 — at yields far higher than Germany’s. That would exacerbate budgetary problems still further. But if the opposition parties stand back and the budget passes, a year of time will bought, and yields can begin to retreat toward their pre-election levels. Writing before the weekend, Christopher Granville and Davide Oneglia of TS Lombard gave two reasons for this scenario: The first is Le Pen. If her caucus abstains, the motion will fail. Abstention would be based on a calculation that this would be best for her paramount goal of winning the presidency in 2027. Second, the left bloc lacks cohesion. Sixty-six of its members are from the mainstream Socialist Party — sufficient, should they abstain, to block the motion even if Le Pen backs it. The odds are therefore skewed to the Barnier government’s survival, and the ‘OAT spread reversion’ trade working.
Even if Barnier survives, the French chaos weakens an already weak Europe as it tries to work out a response to possible tariffs from President-elect Donald Trump once he takes office. On which note: The markets have had a month to digest Trump’s election victory. While also digesting Thanksgiving leftovers, it’s worth checking in on the reactions to developments as he builds what looks likely to be a different administration from his first. America First: US Equities Beat Everyone Else There is no longer any doubt that economic policy will be conducted on a zero-sum basis, assuming that US gains must be at someone else’s expense (a philosophy that China appears to have been following for a while). On Election Day, US stocks had beaten the rest of the world for the year by roughly 10%. Now, it’s over 20%. The Magnificent Seven tech platform stocks are a big factor, but even Bloomberg’s index of the 500 largest US companies that excludes them leads by 15%. Investors buy the argument that this is good news for US stocks, and equally bad news for companies elsewhere: For a really dramatic illustration of the zero-sum approach at work, this is how bank stocks in the US and euro zone (denominated in dollars) have moved through this year. It’s not often a political event is treated as quite such an immediate turning point: Bitcoin Goes Ballistic There’s been no significant correction to the surge that cryptocurrency has enjoyed. Bitcoin had been stuck for years at around the level it reached in early 2021, but has now made a step change predicated on the belief that lighter regulation under Trump will be good for the price. It may also include notions that the government is going to be a big investor in Bitcoin, which would be a mixed blessing. Increased institutionalization of an asset whose greatest virtue is its purported lack of institutions would be an issue, while the presence of a large player reducing the float of readily tradeable Bitcoin would likely increase volatility and make it harder to use as a means of exchange. For now, the judgment is plainly positive: Stronger Dollar Trump doesn’t want a stronger dollar, but the consensus trade is that he’ll get one if he goes through with raising tariffs and cutting taxes. If this happens, and the Federal Reserve doesn’t help to weaken the currency by cutting rates, it sets up a potential epochal battle over central bank independence a year hence. But that’s several chess moves away. As it stands, the reaction hasn’t been uniform. It was interrupted first by the apparently market-friendly Scott Bessent’s nomination as Treasury secretary, and then by Trump’s announcement that he’d impose a 20% tariff on imports from Canada and Mexico (even though they’re covered by a treaty that Trump renegotiated himself in his first term). However, the muted foreign-exchange response suggests confidence that the threat is only a negotiating posture. Meanwhile, the Bank of Japan seems more likely to adopt a hawkish approach, which has sharply weakened the dollar against the yen. The euro has also regained ground (though French developments might jeopardize this). Europe’s political and financial establishment is in a defensive crouch waiting for a Trump social media announcement of tariffs on the EU, but so far that hasn’t happened:  No Sign of Bond Vigilantes Abead of the election, the overwhelming consensus was that Trump 2.0 would be stocks-positive and bonds-negative, as logical effects of a policy of aggressively pursuing growth. But the bond part hasn’t come true. Instead, yields are lower than on Election Day (following a menacing buildup). The long search for a Treasury secretary assuaged the vigilantes in two ways. First, it showed that the Trump team understood that this was a crucial pick. Second, the vigilantes believe that appointing a macro hedge fund manager who learned his trade attacking currencies for George Soros shows that Trump 2.0 won’t do anything too stupid. Much weight is now on Bessent’s shoulders: Inflation There are plenty of risks, of course. The biggest remains inflation. The latest edition of the Personal Consumption Expenditure (PCE) deflator, the Fed’s official target, gives further evidence that inflation is down but not out. Using the statistical purists’ favored trimmed mean version, produced by the Dallas Fed, in which outliers are excluded, the pattern is of disinflation tailing off stubbornly above the 2% target: This doesn’t oblige the Fed to start hiking, although the expectation is now for a maximum of one more cut to the fed funds rate in the next two Federal Open Market Committee meetings. Investors are now very much alive to the disquieting risk that inflation still hasn’t been beaten, just as a new government prepares a barrage of policies that should at the margin be inflationary. Absolute Strategy Research’s latest quarterly survey of asset allocators shows that a majority of global money managers now expect US inflation to rise over the next 12 months, not fall:  Trump has a mandate for tariffs, corporate tax cuts, and an immigration crackdown; but everyone knows that the electorate will not tolerate a fresh wave of inflation. It’s not yet clear how severe the trade-off between policy aims and inflation will be, nor how the administration will deal with it, but it’s by far the greatest “known unknown” risk. Until it arrives, the trade is to keep buying American assets. That’s certainly what the money managers interviewed by Absolute Strategy seem intent on doing:  Musically, I missed the first decade of this century; I was submerged by young children and didn’t get to listen to the radio. But my now-teen-age daughter has introduced me to this rundown of all the number one songs of the decade. Both the worst (You’re Beautiful by James Blunt) and the best (Coldplay’s Viva la Vida) are by British acts, which is nice. The first few dozen songs really are truly awful, so I didn’t miss much. But the decade did produce some gems. I learnt a lot. Have a great week everyone.
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