Transcription

• Speaker #0

  In those uncertain times of France, we put our faith in two things, the constitution and arithmetic. The combination of the two provides a good guide out of the current needs. I'm your host, Jean-Marc. on this exploration and you're listening to the sound of finance an axe aem podcast in a public letter the president of the republic made it plain last week that he would take his time to appoint a new prime minister calling on parties to find the compromises needed to build a majority now that he has formally accepted et al's resignation the government turns into a more restricted current first cabinet which incidentally will allow ministers to take their seat in parliament but there is no time limit you to such state of affairs. In practice, though, a full-scope government will be needed to elaborate a budget for 2025 and steer it through the parliamentary process. The current limbo cannot thus extend too far into August. Article 8 of the Constitution makes it clear that the President can freely appoint any Prime Minister of his choosing. The limit, of course, is that, once Parliament reconvenes, opposition groups can table a motion of no confidence, which would force a resignation of the newly appointed prime minister if it is actively supported by the absolute majority of the lower house, 289 seats. This is where arithmetic matters. The different groups making up the left alliance Nouveau Front Populaire are, so far unsuccessfully, negotiating to determine who they would propose as prime minister to the president. Again, the president is absolutely not bound by any proposal, But more importantly, it is highly likely that a PM supported by NFP alone would be immediately defeated by a motion of no confidence. It might be that the all-intra-left discussion is essentially a way for the various groups to prepare their electorate to a split in the Alliance. The impossibility to agree on aim would allow all factions to take up their freedom. Within the main party within the Ensemble Centrist Alliance Renaissance, tensions are flaring on whether a coalition should be symmetric. That means uncompassing the centre-left and the centre-right, or if it should be skewed towards the centre-right. Numerically, the clearest path to building a stable coalition comfortably above the absolute majority threshold would indeed consist in a symmetric deal. Now, there may be nuances around this. The main centre-right party, Le Républicain, rejects the idea of participating to a coalition government, but also expressed some openness to a legislative pact offering support to a government on a case-by-case basis. This would be close to the British notion of confidence in supply, where a party does not participate to a cabinet, but commits at certain conditions to support a budget and abstains from voting on motion of no confidence. Given the numerical and political constraints, presidential elections will take place in three years and the new legislature could end abruptly in one year once the president has the possibility to dissolve the National Assembly again. This sort of confidence and supply arrangements may also become attractive to some groups on the left as well. Parties, embarked in a confidence and supply pact, could pledge that they are doing their patriotic duty to help unblock the country while maintaining enough political differentiation to retain their chances in the next elections. Now, before such solution is reached, more politicking, so to speak, may have to take place. For instance, some of the Republicans'red lines are probably still too tough at this stage to be easily accepted. by the centrist. The election of the chair of the National Assembly this week will provide some early indication of the level of convergence across political families. We've been arguing since the beginning of this political phase that the budget is the real deadline. While the services of the finance ministry are probably busy reading the technical aspects of the budget bill, they obviously cannot finalize anything without political instructions coming from a full scope government. The bill must be transmitted to parliament on the 1st of October. Around the same time, the French administration must transmit to the European Commission its medium-term fiscal adjustment plan. The normal date is the 20th of September, with possibly some flexibility around that. This matters a lot because a purely minimalist budget bill for 2025 would not suffice. Indeed, it is on the basis of a medium-term plan that the European authorities can decide whether to grant France seven years, and not just four, to bring its deficit back to 3% of GDP. However, in principle, such extension, which would help minimize the adverse effect of the fiscal consolidation and aggregate demand, would be conditional on commitments on reforms and public investment. This suggests that the conversation needs to move rapidly from intra-family discussions to proper granular cross-party negotiations on what could concretely be the basis of the country's macroeconomic strategy. Sssssssssssssssssssssssssssssssssssssssssssss For those who used to listen to an earlier version of this podcast a few years ago, at the time we were obsessing about 1960s and 1970s music and we've decided to move to the 80s with a song by Genesis 1986, Land of Confusion, which you know... probably kind of describes pretty well the current situation in France. And it's my pleasure, actually, as the political dust is settling, or as we wait for the political dust to settle, it's our pleasure to get on this podcast, Gilles Guiboud, who runs European Equity at AXA Investment Managers. So it's going to be a bit confusing for the audience. I'm sorry, because there are going to be two Gilles. button. It should be okay. We have different voices. So, Gilles obviously has been looking at market developments in connection to the political developments in France very, very closely. And my first question to him is going to be pretty simple. How would you characterize, so far, the way the market has been responding to this political uncertainty in Paris?

• Speaker #1

  To me, the first reaction was pretty natural and pretty logical. In fact, it has been a surprise for everyone to have such a decision to change this parliament. So this has changed the level of risk we were putting on the French market. So as such, in such a situation, all investors have to reset their risk appreciation. And it's exactly what we had. We have had a first initial reaction, which has been pretty negative. And while the dust was settling to some extent, we have seen the French market being able to recover slightly what we were losing the first days. So no real surprise for the moment.

• Speaker #0

  On the equity market, there seemed to be quite a sharp distinction between what was happening to banks. on the rest of the market. Has this continued actually, or is it already kind of fading?

• Speaker #1

  What is true is that when we dig into what could be the potential outcome, now we have more visibility on no extreme party will lead the country. It gives some more visibility on the fact that we should not have at least massive... deficit coming with the absence of government. So to that extent, it protects a little bit of all French companies. But it's true that what remains is uncertainty. And as such, banks are the natural, let's say, element to drive or to measure this uncertainty because they have a clear exposure to the government bond. And as we have seen in Italy for years, they are the ones that are really expressing the level of stress in the market. So while we have had French domestic companies that have recovered a lot, at least half of what they've lost after the announcement of the dilution of the parliament, banks in reality have not really benefited from this rebound.

• Speaker #0

  So there remains a sort of negative premium for now. If we fast forward to what could be the outcome, so at some point we're going to have a budget. What is the market going to look at? What is the market going to focus on to try to evaluate how French equity is going to respond to that?

• Speaker #1

  What's worth reminding maybe before answering in more detail, it's just when we look at the CAC current, so the main French equity market index, it was noting that only 15% on average, only 15% of revenues are generated in France. This is below what is generated. in the US, which is roughly 22%. So it's important to keep in mind that, at least for the large corporate, large corporate are mainly global companies on average. So then we have always to be a little bit cautious with average, but it really means that what will happen in France is important, but maybe it will be even more important to understand what will happen in a few months from now in the US. So... Now, if we focus just on the French situation, for sure, as you were rightly pointing, what will happen with a new budget will be important because there is a risk of new taxes. So this would not be too damaging, but this would be certainly a one-off effect. So we should maybe wait to understand if we could face potential... tax increase for those companies. And given the overall budget situation, this is something that could be, let's say, not a big surprise.

• Speaker #0

  So would I be wrong in summarizing your view and saying that the most radical options have been removed from the table, so you're not expecting anything abrupt, but what you will focus on is how much of the fiscal effort is going to be skewed towards tax versus spending cuts. That's the That's basically the way you're going to read it.

• Speaker #1

  Exactly. And especially because we should have avoided the massive risk that was pending on a massive increase in minimum wages, which can be, let's say, necessary for some people, but would have had a really negative impact on many French companies from, let's say, a competitive standpoint. So this risk is now off the table. So now it will be really to focus on which kind of activity. But again, increasing taxes could be just a one-off effect. And for those companies that are massively global, impact should be limited.

• Speaker #0

  Thank you, Gilles. One last question from me to you. Are you going to spend your summer holiday in France or are you spending it elsewhere?

• Speaker #1

  Yes, France is a beautiful country to have a vacation, especially during summer. So we have a beautiful seaside. So it would be a pity not to profit from the seaside.

• Speaker #0

  Perfect. I absolutely concur with that view, Gilles. Well, thanks a lot. And let me continue with maybe some more general comments. And Gilles has alluded to it. by mentioning the US elections because a sort of combination of elections in France and the looming presidential race in the US focus tension on the potential for, let's say, radical policy experimentation. But we think attention should also be drawn to how even mainstream political forces can be affected by a new approach to macroeconomic management, which is straying away from the main principles which have been guiding policymakers since the 1980s. We could define those principles around three main themes, a circumspect attitude towards the role of fiscal policy in cyclical fine tuning, the primacy of monetary policy, and a distrust for direct state intervention in capital allocation. That was really what I learned when I was at uni, unfortunately for me, three decades ago. All this is giving away. to enthusiasm for activist fiscal policy, a critical view of the capacity of military policy alone to deal with inflation, and some appetite for price controls. A very stark shift, I would say. There is a recent paper which has been commissioned by the European Parliament, which encapsulates quite well the current state of thinking. It's a paper by von Kloster and Weber called Closing the EU's Inflation Governance Gap. It focuses on the limits to the capacity of central banks to respond to supply-side inflation shocks. Those supply-side inflation shocks, when they affect systematically important components, such as food, energy, have deep ramifications for the rest of the economy because they profoundly affect consumers'expectations. So it can affect wages, firms, profit behavior, and they can also disrupt production processes. And... Walsh, von Kloster and Weber argue that raising the policy rate to deal with such shockflation, to use the expression, can be very costly in terms of welfare loss, which would call for a multifaceted approach which goes far beyond monetary policy. This is not necessarily new. The two authors recall the experience of post-unification Germany to show how even a very credible central bank, such as the Bundesbank in those days, did not deal with the 1990s inflation shock alone. but was supported by sort of general political mobilization and listing the labor movement, for instance, which brought about wage moderation. We agree with this view. I mean, episodes of correction from high inflation regimes usually entailed more than pure monetary tightening. Paul Volcker did a lot to severely wound the inflation beast in 1980. But the final killing probably came courtesy of the transformation of the US labor market. In France, abolishing the automatic indexation of wages on inflation also played a major role in the 1980s. Yet, von Kloster and Weber argue that shockflation has changed in nature. They highlight in particular greedflation, which saw profit margins expand when food and energy prices accelerated in the wake of the Ukraine war. They advocate the possibility for national governments, in coordination with the EU, to intervene, if need be, in price formation to nip these inflation waves in the bud. Some of this intervention would be pro-market, using the instruments of competition policies more readily. But von Kloster and Weber also explicitly mentioned direct intervention by setting up public supply buffers in the image of the US oil strategic reserves, for instance. But also by using, I quote, selective price controls to correct the overshooting of prices in response to shocks that induce endogenous price uncertainty. They mentioned the European gas price cap as an example. In addition, the authors praised industrial policies with a large dollops of state aids to the extent that they could have a disinflationary effect by removing production bottlenecks. All this would ultimately be the opposite approach to the one pursued in the late 70s, early 80s, or in Germany in the early 1990s. At the time, disinflation was brought about by more market. Today, it would be quelled by less market. Well, some of Kloster and Weber's recommendations are perfectly reasonable in our view. We praised the action of European governments when they introduced the de facto subsidies to mitigate the transmission of all sale energy costs to consumers purchasing power. We believe that without such action, an even larger drift in wage growth would have occurred as workers would have more readily turned to their employers to protect their purchasing power. We're however concerned about the risk that what was exceptional would become run of the mill policies. Von Kloster and Weber come with a very long list of potential shockflation triggers, including the cost of the transition to net zero, which we think are of a structural nature, and propose to embed price monitoring in the European macroeconomic framework. Isabel Weber had come under heavy fire from the economic profession at the end of 2021 when she already argued for price control in an op-ed in The Guardian. Objections became less vitriolic. when the inflation shock proved more persistent than expected and mainstream institutions, such as the ECB, started documenting gridflation themselves, delving deep into corporate margin behavior. We believe still that at this stage, this paper reflects well the economic zeitgeist, so to speak, at least in policy circles. So while the commentariat is now focusing on the most spectacular versions of non-mainstream policies espoused by radical movements, We sense that more central political forces are also yielding to this new macro paradigm. We already covered in our previous podcast how a more muscular approach to international trade was getting tempting, including within European political families which are normally allergic to this trend. The recent history of the European state aid regime is in our view quite telling. The European regulation was initially suspended to accommodate the Ukraine war shock. The changes have now been made permanent. Historically, significant shifts in macro management did not come from the victory of a single political force becoming dominant. But the argument was won by becoming the consensus position. In the US, Keynesian management in the 1960s was supported by both the Republicans and the Democrats. Symmetrically, the Clinton era brought to power teams which were essentially in agreement with the Republicans'free market approach under President Bush Sr. In Europe, the triad of principles for macro-management we mentioned earlier was largely shared across the political spectrum. Symmetrically, it is possible that central political forces try to respond to the strong social demand for more government protection, which is today reflected in the surge of populist movements. by espousing themselves a sort of reasonable version of dirigiste macro-management. A crucial issue, in our view, is how much of this activist push will be offset by more dedication to economic flexibility, for instance in the form of red tape cutting or labour market reform. Given the current political mood, maintaining this balance will be difficult. Thank you very much for listening. We'll be back in September for another Economic Conversation. Be safe.