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16 Jul 2024 | 5 minutes to read
Elections remain in focus in both France and the US, with unexpected drama in both countries.
In France, the second round of French legislative elections provided an electoral upset, with no party gaining a majority, but the left wing alliance, known as the New Popular Front (NPF), gained the largest number of seats. The NPF is made up of France Unbowed, Greens, Socialists and Communists, parties with differing views on many areas of policy, especially foreign policy. France Unbowed’s leader, Jean-Luc Mélenchon, is a divisive but highly distinguishable figure likely to struggle to maintain support from the other parties.
With Macron’s presidency set to run until 2027, the President faces forming a cohabitation government, where he must rely on other parties to govern. Moreover, given the hung parliament, that government will itself be a coalition, with the largest share made up of a further coalition, in the form of NPF. All in all, this is likely to make legislation difficult and government unstable. Further elections are likely next year and a government may not be formed for, potentially, weeks.
The market reaction to this uncertainty has been scaled back from the initial response. While Mélenchon is a euro-sceptic, deadlock in France does not threaten the status of the European Project in the same way as a majority government could have. As a result, European bonds recovered over the week.
In the US, events have taken an altogether more dramatic turn. With the US presidential race getting underway, President Biden’s odds of winning the election appear to have fallen in the same week as his appearance at the NATO summit was blighted by several gaffes. Over the weekend, Trump suffered an unsuccessful assassination attempt. Combined, these events appear to have significantly boosted Trump’s chances of winning the election further, based on betting odds. This opens the door to $4-5trn dollars of extra government borrowing over 10 years, extra spending which could boost bond yields and create a more inflationary dynamic in the US.
Away from the US electoral theatre, US inflation data continues to point to a cooling economy. June’s Consumer Prices Index (CPI) print say year-on-year inflation has cooled to 3.0%, down from 3.3% in May. Headline inflation also cooled, slowing to 3.3% from 3.4%. Within the print, there was significant slowing in the shelter component (the cost of housing), which makes up a third of the index and is a feature the Federal Reserve has long anticipated.
June Producer Price Inflation (PPI) was also published and, while headline inflation was stronger than expected, core PPI remained flat. Combined with the CPI data, this likely means that core Personal Consumption Expenditure (PCE) decelerated in June, paving the way for interest rate cuts. Market pricing based on futures now indicates that a first rate cut is priced for September, rather than November or later. However, a second Trump Presidency could limit the scope near-term for further rate cuts, if fiscal policy supports inflation.
May's UK Gross Domestic Product (GDP) growth data was stronger than expected, with GDP expanding by 0.4% month-on-month, double the consensus forecast of 0.2% growth.
This recovery from no growth in April was driven by a range of factors, including robust performance in the construction sector. Construction output increased by 0.7% month-on-month. Though this was slightly below consensus expectations, it marked a significant rebound from the -1.4% seasonal decline in April, due to poor weather conditions.
Manufacturing production rose by 0.4% month-on-month, in line with consensus, recovering from a sharp -1.4% drop in April. This was driven by strong growth in the food, beverages and tobacco industries, more specifically in alcohol production.
Recent strength in GDP growth comes just as the Bank of England is considering cutting interest rates. This robust economic performance could lead to a more cautious approach to interest rate cuts, as stronger activity could support inflation.
The Bank of England may opt to slow the pace of interest rate cuts or reduce the total number of cuts, as the economy appears more resilient than previously anticipated. However, Monetary Policy Committee (MPC) members have been clear that there is scope to cut rates without making policy accommodative.
August’s Bank of England MPC meeting should bring greater clarity, providing a new set of economic forecasts.
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