Political Shocks and Market Reactions in Europe with Erik Norland

This week on the IBKR podcast, Andrew Wilkinson welcomes Erik Norland, Chief Economist at CME Group, to explore the latest political events in France and the UK. From snap elections in France to the upcoming UK general election, Erik offers expert analysis on the potential market implications. Discover how these political changes might influence investor sentiment and market stability across Europe.

Summary – IBKR Podcasts Ep. 169

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Andrew Wilkinson 

Welcome to this week's IBKR podcast. My name's Andrew Wilkinson. My guest today is CME Group Chief Economist Erik Norland. Welcome, Erik. And you're coming to us from London, right? 

Erik Norland 

Yes, that's right. Yes. Thank you for having me. 

Andrew Wilkinson 

No problem. It's always a pleasure. Well, since you're over in London, we're going to pick your brains on everything European.  

Which affairs over there have come to the forefront over the last couple of weeks? Recently, President Macron in France called a snap election and that sent shockwaves through not just French politics but also across Europe with the big feature there being the rise of the far right.  

Tell us, Erik, in your opinion, how do we get here and then tell us the potential implications for stock and bond markets? 

Erik Norland 

Well, in terms of how we got here, I mean, it's been sort of a long time coming, you know? I Marine Le Pen's father, Jean Marie Le Pen, established what was called the National Front for most of its history in 1974 and originally got around 1% of the vote.  

But during the mid 1980s its vote share rose to around 15%, and it kind of stabilized around 15%, maybe occasionally 18% percent. Until she took control of the party about a decade ago and since then, it's steadily growing.  

The last two presidential elections in the first round, she got around 23% of the vote. In the second round in 2017, she got 33%. In second round last time in 2022 she got 43% of the vote and the legislative elections that were held in 2022 just after that presidential election, Macron's party fell short of an outright majority in the National Assembly.  

So he had to sort of rely on shifting coalitions within that National Assembly in order to get legislation through often it had to be pushed through within a sort of obscure article in the French constitution called the 49-3 that allowed him to pass a very controversial and somewhat unpopular pension reform through a year ago or so.  

And during the European elections which took place in early June, his party dropped very significantly in support and her party rose around 35-38% of the vote.  

So he decided to dissolve Parliament, apparently without even notifying members of his own party. They found out on television that they were essentially being put up for election and the election process in France is very fast.  

So from the time of his announcement to the time of the first round is 3 weeks and then the second round happened just one week after that. So yeah, the polls are kind of suggesting that his coalition is going to drop from 27% around 19% or 18% of the vote.  

The left is going to stay steady at around 25-26% and Marine Le Pen and her allies will advance to maybe around 35-38% of the vote.  

And the remainder will go mainly to the center right party, which governed France for many years under people like Jacques Chirac and Nicolas Sarkozy. It has really, I think, 2 potential outcomes. One is it could have a sort of far-right majority or near majority or it could result in a National Assembly which nobody's anywhere near close to a majority, but either way it could signal a quite a sharp shift in French politics. 

Andrew Wilkinson 

I think the old expression I think it was from my schoolboy history lesson.I think, it was Mitterrand that said, when France sneezes, Europe catches a cold. What are the implications for stock and bond markets as a result of this? 

Erik Norland 

The implication we've seen thus far, especially last week, not so much this week, but last week we saw a very sharp widening of the Bund-OAT spread so that the difference between, you know, German and French debt yield levels.  

That has stabilized. Marine Le Pen’s party has met with the business community in France to sort of reassure them that the party, which has never really held power at the national level, ever, is not going to dramatically increase the size of France's budget deficit.  

And the reason why I think this is such a concern is that France's budget deficit’s already really big. It's running at 5.5% of French GDP this year. And the only country in Europe that has a bigger budget deficit is Italy, which is running a deficit of over 7% of GDP. And is also governed by parties that would have been considered at one time far right, but are now I guess sort of mainstream because they're in power under Sylvia Maloney.  

But you know, these deficits are very concerning, I think to some investors especially. I mean the deficit is sort of like the flow of debt, the rate of its accumulation. The actual stock of debt, the debt to GDP ratio in France is also extremely high at over 100% of GDP. And on top of all of that, France has tremendously high household and non-financial corporate debt as well.  

So when you add all of this up, it's coming to like 325% of French GDP, which basically makes France the most indebted nation in the world outside of Japan. All of this is fine when rates are zero.  

When rates are zero or negative, it doesn't really matter what your debt level is. You can finance as much as you want. But now that interest rates, you know, even though they cut rates 1/4 point, they're still up to 375 on the ECB's main refinancing rate.  

So as various debts roll into maturity and have to be rolled over, the cost of financing all of this is increasing very, very sharply. 

Andrew Wilkinson 

So that's kind of June 30th, the first round of or the next round of French elections. But I guess a week later or just a few days later the next week, July the 4^th is a UK general election.  

We pretty much know that the Conservatives are going to get trounced, but are there any economic implications that you can foresee as a result of the political change? Most likely the Labour Party’s going to get in, right? 

Erik Norland 

If you look at the odds makers, the odds makers are sort of overwhelmingly confident of a Labour majority. They are at a 90% chance of a Labour majority and 95% or greater chance that they have the most seats, anyway, in Parliament.  

This has been so widely signaled and so widely anticipated that I don't think that if that is the result, it won't come as a surprise to anybody. And I think that Keir Starmer himself is a very reassuring figure who’s not expected to dramatically change fiscal policy.  

But there are risks. And so one of the risks is that if the Labour Party wins a very small majority, they can become more dependent on further left members of their Caucus. 

Another thing to lookout for is that the Reform Party, the party of Nigel Farage, who was the leader of the unofficial Brexit campaign, Boris Johnson from the Tories, was the leader of the official Brexit campaign.  

But Nigel Farage's Reform Party has been surging in the polls, and in some of the polls they have surpassed the Tories. One poll that’s out, it was just admittedly an outlier, but out overnight, showed Reform at 24% of the vote. Actually well into second place.  

So you know, there are elements of unpredictability, you know, and also the Liberal Democrats, even though they're kind of running around maybe 10 or 12%, they're very competitive in a number of seats and so it's not really clear exactly how this Parliament is going to turn out, like how big is the Labour majority? Do the Tories have the second most seats here? Do they drop back behind the Lib Dems? Do the Tories finish second place in the popular vote? Or do they drop behind the Reform Party?  

And so I think that there are concerns kind of that either Labour majority is too small, in which case it has to rely on its further left members, which might upset markets.  

Or the Labour majority is so huge that there is no effective opposition, which is something that happened in Mexico, which, as you know, upset the Mexican currency quite a lot when Claudia Sheinbaum turned out not just to win as expected, but win by such a gigantic margin that she has theoretically sort of veto proof majorities in the Mexican Congress that can enact constitutional changes that the opposition can't stop. 

Andrew Wilkinson 

One can never expect anything other than weakness in the Pound to be a benefit for the UK economy, though, right? 

Erik Norland 

Well, it's always a double-edged sword. So on the one hand, weakness in the Pound could be good for exports, could limit imports, which might be good because the UK economy tends to run large current account deficits.  

On the other hand, weak currencies, also inflationary and the UK’s, even though the headline rate of inflation has come down to The Bank of England's target for the first time in quite a few years, that's really only the result of falling European natural gas prices, which have come back down to Earth after a couple of years at stratospheric levels, which is lowering our electricity costs.  

But core inflation in the UK remains over 4%. So it's really, I think around 4.5%, which is really bad. I mean, it's basically double the inflation target. And lastly the current account deficit. There's two ways to view it. On the one hand, you could say, well, yeah, maybe people here in the UK are spending too much money on imported goods. But you have to remember there's another side to it.  

The flip side of the current account deficit is a capital account surplus and the capital account surplus exists primarily because people in other countries would rather invest their money in the UK than invested it in their own countries. And that's a testament to the sort of solid perception of the UK's legal system at defending private property rights. 

Andrew Wilkinson 

Erik, you mentioned earlier that the ECB had cut interest rates to 3.75% at its June meeting. Is this the ECB adjusting rates to where they believe that they now should be after a tightening cycle or are we going to see more cuts develop over the summer and the rest of this year? 

Erik Norland 

Well, the Euro ESTR future, which trades on our exchange, is very much showing that traders are expecting further cuts. So they don't see this as being a one-off. Part of the thing is that the Eurozone's core inflation rate has been declining.  

It's been declining a little bit faster and more consistently than similar measures in the US or in the United Kingdom. Those core inflation rate numbers have come down below 3%. It's still above the ECB's target, but at least it's moving in the right direction. The other thing is that the Eurozone’s economic growth rate has been extraordinarily weak, and now, on top of all of that, they have a widening of intra-European bond spreads, which might be a little bit disconcerting for the European Central Bank.  

Oh, I have to point out that the European bond spreads are not by any means at extreme levels like they were back in 2011 or 2012. I don't think the ECB would want to see momentum back in that direction. 

Andrew Wilkinson 

Thank you very much to Erik Norland, Chief Economist at the CME Group over in London, for joining me on this episode. Erik, thank you. 

Erik Norland 

Thank you. 

Andrew Wilkinson 

And to the audience, if you enjoyed today's episode, please don't forget to subscribe to the series wherever you download your podcasts from.