France elections

Since the establishment of the Fifth Republic in 1958, the French parliament has never been as fragmented as it is now, with no party coming close to a majority. A coalition government is arithmetically possible, but politically difficult to achieve. A period of instability is likely before an agreement can be reached. Meanwhile the deteriorating fiscal situation will be the most pressing challenge facing the next government.

Financial markets have priced out the tail risk of more extreme scenarios, but protracted political and fiscal uncertainty justifies a higher risk premium attached to French assets. We expect the 10-year French OAT spread over Bunds to hover in a range between 60 bps and 80 bps in the months ahead, and the euro to trade in the 1.05-1.07 range against the USD in H2.