A slightly strange week in financial markets given the focus has been firmly on France and South Korea
Maybe the first and last time I’ll get to say that. Both countries have seen political turmoil resulting from their minority governments attempting to pass a budget for next year. While the methodology in trying to force the budget deals through may have been different, the outcome looks to be the same – a period of uncertainty followed most likely by new elections.
The collapse of the French government has had an air of inevitability about it ever since the parliamentary elections in July produced a three-way split between the left wing, right wing and centre ground parties. President Macron chose Michel Barnier to lead a minority government in parliament and the fragility of this arrangement has been made clear as discussions progressed over the budget for 2025 against a backdrop of a significant budget deficit. Barnier’s proposals of a combination of tax rises and spending cuts amounting to around €60 billion garnered no support on either side of parliament so when the budget debate began in Parliament on Monday it was immediately clear that without significant concessions, the budget would not pass. Prime Minister Barnier chose to use constitutional powers to force the budget through without a vote, which inevitably caused the opposition parties to follow through on their threats to table a motion of no confidence in the minority government. Barnier told members of parliament “I don’t think French people will forgive us for choosing party interests over the future of the country. Now, everybody will need to assume their own responsibility as I have assumed mine.” The confidence debate took place on Wednesday and the ensuing vote, as expected, went against the government.
The last successful no-confidence vote in France was in 1962 so there are limited recent precedents as to what comes next. Per the constitution, fresh elections cannot happen until the summer so President Macron can propose a new PM, or a caretaker government under Barnier but there is no guarantee of any stability given the fractured state of Parliament after last year’s elections, with three broadly equal blocs and no party near a majority. In the short term, with the Barnier budget in the bin, Parliament can use a special law to extend the existing budget with no changes so the bills will get paid, but the political turmoil will continue, and several months of deadlock appear to be ahead. President Macron reiterated he would not resign and will see out his term in office to 2027. However, with such divided politics, France looks near-ungovernable for the moment and any new Prime Minister appointed by Macron will likely end up in a similar position to Barnier unless they can secure some support from the left or right sides of the French parliament. President Macron said last night that he would appoint a new Prime Minister “in the coming days”. Marine Le Pen in response hinted at a path to compromise, saying a budget could be agreed “in a matter of weeks” if the incoming Prime Minister was prepared to cut the deficit at a slower pace. New elections appear likely; whether they solve this issue is a question for 2025 to resolve. Unsurprisingly French assets have struggled against this backdrop – the barometer for market worries being the spread between French and German government bonds, which touched levels this week last seen in July 2012 in the eurozone debt crisis before Mario Draghi stepped in and saved the day. What is positive is there have been no signs of contagion anywhere else in the eurozone – this is very much a French problem.
Meanwhile, in South Korea, President Yoon Suk Yeol declared martial law in a TV address, a move that shocked the nation, and roiled financial markets. His decision was later reversed after a swift vote against it in the National Assembly. The President said the decision was made to “protect freedom and constitutional order” and came after months of deadlock in parliament between the President’s minority government and the main opposition Democratic Party over the budget for 2025. Yoon claimed his move was to protect the country from “anti-state forces” and North Korean sympathisers. The Opposition parties likened the move to a coup and rapidly submitted proposals to impeach Yoon along with the defence minister and safety minister, accusing them of treason. The Korean Won initially fell by 2.67% against US Dollar to a 2-year low, while overnight futures on the KOSPI index fell 5.44%. The dramatic moves were somewhat reversed in the aftermath of the parliamentary vote. KOSPI closed down 1.44% in cash trading. The Finance Ministry said it planned to “deploy all possible market stabilising measures, including unlimited liquidity”. The move by Yoon appears to have been a sign of desperation to push through a budget that his minority government looked unlikely to get through parliament. As a result, with the impeachment process underway, the outcome of his actions appears to be his rapid political demise and new elections in early 2025.
Elsewhere in politics, Ukrainian President Zelensky suggested that parts of Ukraine still under his control should be brought “under the NATO umbrella” to bring an end to the ‘hot phase’ of the war with Russia. Such a move from NATO is unlikely though there is a potential path via ‘security guarantees’ of some kind. It’s clear that the change in the US government is proving a catalyst for a shift in thinking from Zelensky, who recognises that he has a very weak hand in the absence of continued support from the US. On Trump, Zelensky said “I want to share with him ideas, and I want to hear from him, his ideas”. Zelensky has previous refused to countenance any territorial sacrifices, but it appears Trump’s election is forcing some fresh thinking and pragmatism.
We’ve heard from plenty of central bankers this week as the final rate setting meetings of the year approach. In the UK, while the Bank of England is expected to remain on hold, Governor Andrew Bailey told a Financial Times conference there is scope to “reduce interest rates at least four times in 2025”, noting the bank would continue to pursue “gradual” reductions, implying quarterly rate cuts. Markets are pricing only 87 basis points of cuts next year, and Bailey did note some uncertainty to the impact of the budget on inflation, as companies decide how to absorb (or pass on) the increase in National Insurance contributions next April. In the US, market expectations of a December rate cut have climbed over the week, helped by dovish commentary. Fed Governor Christopher Waller said, “I am leaning toward continuing the work we have started in returning monetary policy to a more neutral setting”. On December meeting, he said “an additional cut at our next meeting will not dramatically change the stance of monetary policy and allow ample scope to later slow the pace of rate cuts, if needed.” The Federal Reserve of San Francisco’s Mary Daly suggested more rate cuts to come; “whether it’ll be in December or some time later, that’s a question we’ll have chance to debate and discuss in our next meeting, but the point is we have to keep policy moving down to accommodate the economy”. Says the neutral rate has likely moved “closer to 3%”. Chicago Fed’s Austen Goolsbee said rates will “come down a fair amount from where they are now”. Fed Chair Jay Powell sounded a little more hawkish this week, pointing out the US economy is stronger than the Fed expected and while the Fed is still “on path” to bring rates lower, the Fed “can afford to be a little more cautious as we try to find neutral”. US markets, seemingly in a festive mood, still saw record highs this week, and expectations for a Fed rate cut on 18 December stand above 75%.
Source: Columbia Threadneedle Investments as at 6 December 2024
