The week ahead: French budget woes and payrolls
At the start of this week, the focus is likely to be on France. On Sunday, Marine Le Pen said that her party’s talks with the government led by Michel Barnier, had broken down, which paves the way for a no-confidence vote in the technocratic government that has no majority in Parliament. The no-confidence vote could come as early as Wednesday. If Barnier loses this vote, and at this stage it is very hard to see how he could win the vote, then European political woes could be front and centre as we move towards 2025. An election is expected to take place in Germany in February, however there cannot be another election in France until July next year, which opens the door to months of political struggle and inertia as the country tries to deal with its budget deficit, which is more than 6% of GDP.
Marine Le Pen: the most powerful politician in France
Although Marine Le Pen did not win an outright majority in June’s election, she has never been more powerful. By walking away from Budget talks with the government on Sunday, she has the power to destroy Barnier and his mission to get France on a sustainable fiscal track. This could also damage President Emmanuel Macron’s reputation. The election back in June caused a wobble in French bond yields which rose close to the levels reached in 2012, at the peak of the Eurozone debt crisis, and there are signs that the bond vigilantes are swirling once more as France’s Budget crisis unfolds.
It is unusual for a government to collapse this close to the year-end deadline to pass a budget, however, the budget could get through using emergency measures. If this happens, then it could trigger spending cuts and other austerity measures that may hit economic growth. It would almost certainly come with election risks. Another election in 2025 may cause more stress, especially since it could allow France’s more extreme parties to take power. It is hard to know how Le Pen’s National Rally would tackle France’s 6% deficit. Thus, French political risk is growing at the same time as the focus on national debt levels is heating up. This is a surefire way to catch the attention of the bond vigilantes.
European sovereign risk is reassessed
French bond yields may have fallen in November, however, their relative performance vs. other Eurozone members suggest a repricing of sovereign debt risk in the currency bloc. French bond yields are higher than Spain and Portugal’s yields, and they rose above Greek 10-year bond yields at one stage last week. The spread between French and German 10-year bond yields widened to 2012 levels last week, before falling back to 80bps. However, a further recovery in the yield spread could be tricky if a no-confidence vote in the French government is lingering over markets.
The euro takes a knock as political risks and tariff talk weigh on sentiment
Since Donald Trump’s victory in the US election, the euro has been the worst performing currency in the G10 FX space. EUR/USD is lower by 3.23%. Some lackluster economic data and the prospect of hefty rate cuts from the ECB next year are also adding to the pressure. The chance of a recovery by the end of the year is unlikely if French political risk grows or France is plunged into a sovereign debt crisis, as the bond market grows weary of spendthrift governments. The euro has opened lower at the start of trading this week, and French bond yields may follow suit later on Monday.
Lagarde has final say before next week’s ECB meeting
This week, the Eurozone unemployment rate, retail sales for October and German factory orders will all be watched closely. The German factory orders are expected to decline in October, however, industrial production on Friday could paint a more upbeat picture about the strength of this important sector of the German economy. The focus will also be on ECB President Lagarde, who is testifying to the European parliament this week. This is her last speech before the blackout period ahead of the ECB meeting on 12th December. She is likely to be grilled on the rise in Eurozone CPI to a 4-month high, and she may be asked if French political woes will impact ECB policy.
If she sounds concerned about inflationary pressures, especially service prices, then we could see a further scaling back of expectations for a 50bp rate cut from the ECB this month. The market is currently pricing in 38bps of cuts from the ECB next week, this is down from more than 45 bps of cuts a week ago. We do not think that a 25bp rate cut from the ECB will be considered a hawkish surprise that will boost the euro. The ECB is likely to say that it will continue to cut rates regularly due to growth fears, without the need for super-sized rate cuts at this stage.
Can the President elect Trump a Santa rally?
The election of Donald Trump has had a huge impact on global financial markets. As we move into December, US stocks have posted fresh record highs and November was the best month of the year for the S&P 500 and the Dow Jones, they both rose 5.3% and 6.8% respectively, while the US mid-cap index, the Russel 2000, rose more than 10% on the month. However, while US equities have basked in Trump’s glory, other markets have been out in the cold. Fears of Trump’s tariffs have hurt European stocks, the Eurostoxx index fell by nearly 4% last month. Although the UK is expected to avoid the worst of Trump’s tariffs threats, the FTSE 100 fell 0.16% in November. The French CAC was one of the weakest European performers, as political woes weighed on market sentiment.
Breaking down the stock market performance in the US market can give us an insight into how Trump is impacting the market. The top performers on the S&P 500 were automobile producers, consumer electronics, the oil and gas sector and consumer finance. The weakest performers include the gold index and semiconductors. The leadership of the S&P 500 has shifted dramatically under Trump. Although Nvidia is one of the top performers on the S&P 500 this year, its position is dropping, and Texas Pacific Land, a real estate company, has taken its place as the second-best performer in the S&P 500 this year. December is traditionally Santa rally territory in the US. Federal Reserve rate cut hopes are also crucial for a stock market rally. The question now is, will Trump say something or do something that could knock sentiment towards US stocks? We think that the fundamentals remain strong for the US stock market to perform well into the end of the year, but a misstep from Trump could temporarily hurt sentiment.
What a difference an election makes: Tesla the new star of the US stock market
The outperformance of the auto sector in November is almost entirely down to the performance of Tesla, which has surged in recent weeks. Its stock price is higher by more than a third in the past month. In contrast, Ford and GM have been reeling from Trump’s tariff talk. They both import parts and have car assembly factories in Mexico and Canada, two countries that Trump singled out last week as ripe for large tariffs when he takes office. Ford and GM have seen their share prices rise by 7% in the past month, significantly underperforming Tesla. There has been worse fortunes for European car makers. VW’s share price is down by 8% in the past month, while Stellantis’s share price rose by 2% this month. The marker of Fiat and Jeep has seen its share price dive by more than 50% since April, however, it may fall further on Monday after the announcement on Sunday that its CEO was stepping down, and a replacement would be found next year. While the car sector globally is facing an existential crisis, the US auto sector is likely to be more resilient than most.
Trump inflation fears overdone
Elsewhere, in the lead up to Trump taking office, there were fears that his policies would unleash another wave of inflation. However, since he won the election on 5th November 10-year US Treasury yields have fallen by 13bps, outperforming 10-year Gilts, and 2-year Treasury yields have fallen by 3 bps. Thus, as we move into the final month of the year, fears about President elect Trump unleashing another wave of inflation are receding, which is also good news for stocks. This is also a reflection of Fed policy. There is now a 66% chance of a rate cut from the Fed when they meet later this month.
Biden still impacting markets in last few weeks of Presidency
While Trump is having an outsized impact on financial markets, it is worth remembering that President Biden can still set the policy agenda for the next few weeks. His administration has proposed that Medicare and Medicaid should pay for anti-obesity drugs regardless of whether someone has another underlying health condition. This boosted the share price of Eli Lily, and Novo Nordisk last week. Added to this, Nvidia and other semiconductor stocks helped to push the main US blue chip indices to record highs on Friday, after Biden attempted to water down curbs on industry sales to China. This helped the magnificent 7 to return to dominance at the end of last week.
Payrolls could seal the deal on a rate cut from the Fed
US economic data is also worth watching this week. ISM surveys are released along with factory orders and durable goods sales. However, the focus will be on the labour market report released on Friday. The market expects a reading of 200k, up from 12k in October. The number of monthly payrolls is expected to return to normal after October’s report was impacted by the Boeing strike, which is now over, and the fallout from hurricanes that hit the American south. A 200k rate is ok, however, it does not suggest a strong rebound in the US labour market. The underlying pace of job growth may not be enough to stop the unemployment rate from edging higher in the coming months. The unemployment rate is expected to remain steady on Friday, with 4.1% expected for November, although the risks remain to the upside, in our view. Average hourly earnings are also expected to edge down to 3.9%. Overall, if the November payrolls report comes in line with expectations, then it may boost the chances of a rate cut next month, and we could see this get priced in above the current 66% probability of a rate cut currently expected.
UK bond auctions in focus
Elsewhere, in the UK the final reading of the PMI surveys for November could confirm a slowdown in the UK’s private sector, which gives a warning sign about future growth. The BRC’s early reading for November retail sales will also be worth watching, to see if Black Friday discounts have boosted sales, and to get a gauge of the strength of the UK consumer as we lead up to the important holiday season. Bond auctions will also be worth watching this week, due to the sharp drop in ratings for the new Labour government and the weakened growth outlook. There is a 30-year bond auction on Tuesday, and a 7-year auction on Wednesday. Both will be scrutinized to see how demand fares for UK government debt after the recent budget. A strong auction is a sign of confidence in the UK; however, it could also be a sign of rebalancing away from European debt as political risks are set to rise. At the start of the new week, the pound is also weaker, and GBP/USD is back below $1.27, as the dollar regains control as King of the G10 FX space once more.
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