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Opinion Credit
This year sees elections affecting about 49% of the world’s population
by Duncan Sankey
Duncan Sankey
Portfolio director and head of credit research
Cheyne Capital
There are many reasons to fear the populist right, but markets are more scared of uncertainty
Credit markets had been stoical in the face of geopolitical risk until President Macron announced a surprise election after the far-right National Rally (RN) booted his Besoin d’Europe coalition into a distant second place in the European parliamentary vote.
Far from shoring up the liberal democratic centre, his action initially raised the prospect of an RN-dominated Assemblée Nationale and prime minister, whose policies (based on their 2022 presidential election manifesto) would raise France’s public deficit by 3.9 percentage points per year (from 5.5% currently), according to the Institut Montaigne. European credit indices reacted by widening over 20% in two days before gradually retracing to just over 5% of their pre-announcement value, as conviction grew that the centre-left block created before the second round of polls would frustrate an outright RN majority. This conviction turned out to be correct, and the second round of voting relegated the RN to third place. However, this is still an opportune moment to consider the economic impact of populist right-wing governments.
Arguably, we’ve already seen this movie. Giorgia Meloni was elected PM in Italy on a far-right ticket, but economically has proven mainstream conservative, scrapping the citizens’ income benefit, eschewing big(ger) spending and cosying up to the EU. The RN at least feigned use of the same playbook. Its PM-designate, Jordan Bardella, has equivocated over earlier pension commitments, although he allegedly remains wed to cuts to VAT on food and energy, which could cost as much as EUR 13.6bn a year. However, the RN does manifest an awareness of market reactions, and the adoption of Meloni-style pragmatism could assuage bond vigilantes.
Paying the price of a centre-left coalition
Meanwhile, faith in the fiscal continence of a centrist coalition may be misplaced. Centrists will need to buy off support on the left by delivering some of their pet projects (higher minimum wage, an energy price freeze or cancellation of cuts to unemployment insurance), most of which involve extra expenditure. In addition, a union of the centre and the left is one of convenience, not love, and will likely be liverish and ineffective. Its impact on a public frustrated by a perceived democratic deficit could make the RN a shoo-in for the Elysée Palace in 2027, buoyed by the likely successes of other extreme right movements elsewhere in Europe. The market would likely react negatively to that kind of uncertainty.
Things seem less ambiguous in the US. Unless the Democrats can conjure a deus ex machina to save the day, Donald Trump will most likely be the next president. His calls for the extension of his 2017 tax cuts, coupled with lower corporate taxes, will add to the US’s over 6% budget deficit, while a more aggressive tariff framework will likely stymie attempts to bring inflation down to 2%. This argues for a steeper yield curve (whatever becomes of policy rates), which will challenge the attempts of deep-junk credits to deal with an impending refinancing cliff. (Cash-flush investment grade should be fine.) So far, so bad.
Deregulation may counter a rising deficit
However, on the micro side the outlook is more encouraging (at least for business interests). Trump will want to strip back regulation, using, where possible, executive orders if Congress proves recalcitrant. He will likely slow efforts to green the economy (good for oil and commodities), dial back incentives for EVs (profit-enhancing for the Detroit 3), frustrate worker organisation efforts (limiting employment expenses) and weaken federal oversight (taking out regulatory costs). He can significantly ease his path by co-option of the infrastructure of government. This is already evident in the Supreme Court of the United States abrogation (on partisan lines) of the Chevron Doctrine, a rule in administrative law that required judicial deference to reasonable interpretations of statutes made by government agencies (and informed by their scientific advisors), where Congress had not addressed the underlying matter directly. This will allow companies to issue many more legal challenges to existing rules promulgated by the likes of the EPA (especially in the regulation of greenhouse gas emissions), FDA or even financial markets regulators.
Overall, this year sees elections in 64 countries plus the EU. These affect about 49% of the world’s population. Markets never like that kind of upheaval, especially when it catapults unknown forces into positions of power. However, the outcome for business and markets from the ascendancy of right-wing populist movements is far from clear-cut. And business has found ways to make accommodations before.
