Fund managers will often say that politics has little influence on financial markets, but with soaring debt levels, politics may matter more than usual.
- The French fiscal deficit currently sits at over 5% of GDP, and its structural deficit at 112% of GDP
- The US deficit sits at over 120% of GDP, which is creating significant fragility
- The level of Italian debt may have led Giorgia Meloni to be far more market friendly than some of her earlier rhetoric would have suggested
Amid the turmoil of the French parliamentary elections, it is becoming increasingly clear that the problem for financial markets may not be the potential rise of a far right government. Rather, it seems that the real problem is the French government finances, and the politics are only a sideshow.
The real fear is that political sclerosis will prevent the country tackling its entrenched fiscal deficit. This currently sits at over 5%, and there appears to be little political will on any side to address it. Even in more stable moments, policymakers have struggled to deliver any spending cuts and have acquired a reputation for breaking their fiscal rules. With the current instability, cuts now seem vanishingly unlikely.
It is possible to make a similar argument for the US. Financial markets do not necessarily care about Donald Trump’s plans to build walls or destabilise NATO. However, they do care about his plans to cut taxes at a time when the fiscal deficit sits at over 120% of GDP. They also worry about the impact of raising tariffs when the economy is fragile. In other words, it is possible that financial markets wouldn’t care a bit about French or America’s wayward politics if debt levels weren’t unsustainably high.
There is an alternative argument: that high debt levels will constrain even the most wayward politician. In Italy, for example, Giorgia Meloni has been far more market friendly than some of her earlier rhetoric would have suggested. The constraints of Italy’s 140% debt to GDP ratio may have tempered her worst instincts.
However, Pictet’s Frederik Ducrozet recently pointed out that Meloni had experience of governing and dealing with the business community before she was elected prime minister in 2022. She had built some strong relationships and influence. In contrast, the French National Rally leaders have no government experience, no strong relationships with French businesses and little influence in European circles.
Equally, a high deficit is unlikely to tame the wilder instincts of Donald Trump. The US can run a higher deficit than its peers thanks to the Dollar’s position as the reserve currency, and Trump is likely to use this flexibility to maximum effect.
There can be little doubt that financial markets would be far more sanguine about the rise of populist leaders in Europe and the US if the finances of developed market countries were in better shape. It is where politics and financial markets collide.
