Risky China Stocks Slide as Market Braces for 'Survival of the Fittest

Economic

Summary:

Regulators gather in Shanghai amid balancing act on raising standards.

Chinese stocks deemed risky by mainland exchanges have tumbled after the government vowed to set higher standards for companies to stay publicly listed, highlighting the delicate balancing act Beijing faces in reforming its capital markets without spooking investors.

ST, or "special treatment," stocks have come under the spotlight in recent weeks, after the government said it would strengthen oversight of listed companies. Exchanges in Shanghai and Shenzhen add the ST label to companies' stock codes to warn investors of certain financial risks, such as consecutive years of net losses, or violations of exchange rules. Those at risk of delisting will have an additional asterisk in front of them.

An index of ST stocks, compiled by data provider Wind, hit a record low on June 6, down 51% from the start of the year. It has since regained about 3%. China's benchmark SSE Composite Index is up by 1.9% since the start of the year.

The sharp decline has raised concerns over investors being saddled with big losses. While ST stock prices are generally low, investors buy them in anticipation of a rise when the company's problems are resolved and the ST label is removed.

"With the trend of some acceleration in the number of delistings in the short term, the rights of investors in different areas need to be protected," researchers at financial services company Ruida Futures said in a recent note. A mechanism to protect investors will be necessary to "alleviate the market's current anxiety," they added.

The sell-off of ST stocks accelerated in April, when the State Council -- China's central government -- announced a nine-point guideline for the "high-quality development" of the country's capital market. One key item was putting in place stricter rules for delistings, such as "tightening the criteria for mandatory delisting," and "tightening financial delisting indicators." The measures have raised expectations that regulators may be quicker to kick problematic companies off the country's stock exchanges.

Investors will be watching for more details when securities, banking and currency regulators meet in Shanghai for a two-day conference, the Lujiazui Forum, starting Wednesday.

On the first day of the forum, the head of China's securities watchdog said it will protect investors by beefing up oversight of the country's capital market, as it aims to lure long-term investment and reign in speculative trading activity. "We must put strong supervision in a more prominent position," Wu Qing, chairman of the China Securities Regulatory Commission, told the attendees, according to state media.

He said the CSRC will create conditions to attract more medium- and long-term capital, including venture capital and private equity investment. On the other hand, supervision of high-frequency quantitative trading and over-the-counter derivatives will be strengthened, he said.

Wu, who took office earlier this year, said listed companies will be guided to make better use of cash dividends and share buybacks to provide returns to investors. Regarding investor protection when companies are delisted, he insisted that violations must be pursued "until the end." Shanghai's tech-focused STAR market will also be reformed to further highlight its "hard science and technology" features, Wu said.

Wu Qing, chairman of the China Securities Regulatory Commission, attends a news conference in Beijing in March. (Photo by Mizuho Miyazaki)

Michelle Lam, greater China economist at Societe Generale, said the "most essential" point of Wu's remarks at the Shanghai forum on Wednesday morning was his message on "how to develop a source of long-term, stable funds to come to the market." The Hong Kong-based economist told reporters that she "would like to see more concrete measures coming out from the CSRC to actually encourage insurance funds and pension funds to increase the allocation in equity."

She called that a "push" factor, while saying a "pull" factor would be the chairman's initiative on corporate governance improvement at Chinese companies. "The new regulator is really focusing on this measure," she said, adding there is a long way to go. "It remains to be seen [whether] this really manages to revive the confidence in the people's mindset in the equity market."

Some have high hopes for capital market reform. About 5,300 stocks are listed across mainland exchanges, the number having doubled over the past decade. But the lack of an active delisting system has resulted in more than 100 ST stocks maintaining their listed status.

In an April report, Goldman Sachs said the phenomenon was "averaging down the overall market profitability and investment appeal." It said shares could rise as much as 40% if policy-driven reforms bring China's equity markets on par with global leaders on shareholder returns, corporate governance standards and long-term investor ownership. The nine-point guideline also requires companies to make their dividend policies clear when going public.

But a surge in delistings could inflict big losses on individual investors and dent their confidence in the market.

Dalian My Gym Education Technology, a Shenzhen-listed provider of education services to young children, was hit with the ST label on May 6 after reporting negative net assets in its 2023 annual report. Its shares plunged, trading was halted last week and the company said it received a notice from the Shenzhen exchange that it will be delisted.. Zhongrun Resources Investment, a mining and real estate company, was also slapped with the label after reporting three straight years of net losses.

China's securities regulator sought to calm market jitters over a wave of delistings, saying earlier this month that while a "survival of the fittest mechanism is gradually taking shape," it does not expect the number of companies delisting to increase significantly in the short term. The watchdog "attaches great importance to the protection of investors" involved in companies that delist, it added.

Source: NikkeiAsia

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ING

Economic

Rates still on hold but likelihood of cuts are rising

The People's Bank of China kept the one-year medium-term lending facility rate unchanged at 2.5% today, in line with market expectations.

Last Friday's May aggregate financing data rebounded from April's but came in softer than market forecasts. RMB 2.06tr of new aggregate financing and RMB 819.7bn of new RMB loans showed weak credit activity continuing. This was of little surprise; we have been repeatedly stating in the past few months that loan demand remains inadequate and real interest rates remain too high given the current state of the economy, and that a rate cut would be beneficial to support the economy at this juncture. Inflation should pick up more toward the second half of the year but is unlikely to be an impediment to rate cuts given how low it has been in the first half of the year.

We believe that in conjunction with today's data releases and the start of rate cuts in other central banks such as the European Central Bank and Bank of Canada, the odds of a PBoC rate cut in the coming months have risen. It is likely that the PBoC has held off from rate cuts to date in consideration of the top level policy priority to maintain currency stability at a reasonable and balanced level. However, economic data developments have continued to add to the case for a rate cut, and could cause a PBoC cut even if the Federal Reserve remains on hold. We expect two rate cuts of 10bp each before the end of the year, though this could come in the form of one larger rate cut as well, depending on policymakers' priorities. Two smaller rate cuts could result in less short term depreciation pressure versus one bigger cut. China's Sluggish May Economic Data to Increase Calls for Rate Cuts_1

China's Sluggish May Economic Data to Increase Calls for Rate Cuts_1

Property market continued to slump despite supportive policy push

China's 70-city housing prices continued to decline in May, with new home and used home prices down -0.7% month-on-month and -1.0% MoM respectively, both seeing the steepest monthly sequential declines of the current cycle. From the peak, new home prices have declined -6.4% and the secondary market has declined -12.3%.

Of the 70 city sample, only two cities (Shanghai and Taiyuan) saw an increase in prices in May for new homes, while none saw an increase in the secondary market. This was notably worse off compared to April, when six cities saw increases in new home prices and one city saw an increase in secondary market prices. Year to date, two cities saw new home prices increase, and none saw secondary market prices increases. 16 and 48 cities within the sample have seen declines of over 3% in primary and secondary markets respectively. New home sales remained well in contraction at -27.9% year-on-year YTD.

Real estate investment fell to -10.1% YoY YTD in the first five months of the year, down from -9.8% YoY YTD in the first four months of the year. Once again, this came in weaker than market consensus expectations, even after economists have turned more pessimistic on this indicator. New home starts fell -24.2% YoY YTD, which was a slightly smaller decline than previously.

This data was certainly on the disappointing side and may ring some alarm bells, as May's policy support package has not yet translated to a slower decline of housing prices, let alone a stabilisation. This data further indicates that the property sector will remain a headwind on growth this year. With that said, we caution against overreaction, and it is still worth waiting for a few months of data as some lag could be expected.

Retail sales rebounded on base effect as categories remained uneven

May retail sales rose to 3.7% YoY, up from 2.3% YoY in April. This was a little weaker than our forecasts for 4.1% YoY growth, but well above market forecasts for 3.0% YoY. The recovery is mostly a base effect story, as last May saw a sharp decline in retail sales, but also showed some positive signs that the impact from trade-in policies may be starting to take effect. Year to date growth remained unchanged at 4.1% YoY.

In terms of subcategories, the biggest movement was in cosmetics, which surged 18.7% YoY after seeing negative or low single digit growth for most of the year. As trade-in policies started to take effect, housing appliances also saw an increase to 12.9% YoY. Given the limited time window for many of these programmes, the boost may be realtively short-lived. The "eat, drink, and play" categories which we have preferred continued to outperform the headline in May. Catering (5.0%), tobacco (7.7%), sports & recreation (20.2%) continued to remain well above headline growth despite a high base from 2023. There was very limited appetite for big ticket purchases, as evidenced by negative growth in retail sales of gold and jewellery (-11.0%) and auto (-4.4%).

Fixed asset investment continued to slow in May

Fixed asset investment (FAI) growth slowed for the second consecutive month in May, down to 4.0% YoY YTD from 4.2% YoY YTD. This came in weaker than both our and market expectations.

Most major categories slowed slightly across the board in May. Property investment and tepid private sector investment (0.1% YoY YTD) continued to drag overall investment. The public sector (7.1%), manufacturing (9.6%) and infrastructure (5.7%) on the other hand remained the main areas of growth, but slowed slightly in May. After the proceeds from the central government's ultra-long term bonds are put to use, we could see some stabilisation of investment growth in the second half of the year. It is likely that in the near term, investment growth will continue to be heavily driven by the public sector, as private sector sentiment has yet to recover. It is possible that potential rate cuts could help support private sector investment to an extent, but this recovery will likely take time and a sustained policy rollout.

Industrial production slowed by more than expected

May industrial production growth fell to 5.6% YoY down from 6.7% YoY, which was a steeper than expected drop. Manufacturing has so far been the main upside surprise for growth in the year to date, but may be coming under more pressure in the coming months as tariff actions against Chinese autos could start to restrict manufacturing demand.

Auto production fell to 7.6% YoY in May, which came in considerably softer than the growth in the previous months. The overall year to date growth slowed to 10.5% YoY as a result. With tariff actions from the US and EU set to take effect in the coming months and likely to impact export demand, auto production could come under more pressure in the second half of the year.

On the brighter side, hi-tech manufacturing continued to show solid growth in May, growing 10.0% YoY. The computer, communications, and other electronic equipment category also exhibited strong growth of 14.6% YoY. Amid a technology self-sufficiency push, these categories are likely to remain strong in the foreseeable future. China's Sluggish May Economic Data to Increase Calls for Rate Cuts_4

China's Sluggish May Economic Data to Increase Calls for Rate Cuts_4

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Warren Takunda

Economic

Japanese export values rose 13.5% on year in May for the sixth straight increase, led by solid global demand for automobiles and Asian purchases of semiconductors, while export volumes were down for the fourth month in a row, data released Wednesday by the Ministry of Finance showed.

The pace of increase was slower than the consensus forecast of a 16.1% gain but faster than the 8.3% rise in April.

Import values rose 9.5% (consensus was an 11.4% rise) after rebounding 8.3% in April and falling 5.1% in March. The increase was led by continued solid demand for computers as well as crude oil and refined petroleum products whose import costs have been pushed up by the protracted weakness of the yen.

The trade balance recorded a ¥1,221.3 billion deficit (versus the median forecast of a ¥1,298.5 billion deficit) after showing a revised ¥465.6 billion deficit in April and a ¥382.4 billion surplus in March. It was narrower than a ¥1,382.3 billion (¥1.38 trillion) deficit in May 2023 and a record shortfall of ¥3,506.43 billion (¥3.51 trillion) hit in January 2023.

Shipments to China, a key export market for Japanese goods, posted their sixth straight increase after a year-long decline through November last year amid a gradual recovery in the world’s second-largest economy. Japanese exports to the European Union fell on year for the second straight month, hit by lower demand for automobiles and steel. Exports to the U.S. remain robust, up for the 32nd straight month on autos, after hitting a record high amount in December 2023.

Japan’s economy marked the first slump in two quarters in January-March, down 1.8% annualized, after it narrowly averted a second straight contraction in the final quarter of 2023. Looking ahead, the economy in April-June is expected to show modest growth of about 2% annualized as auto production resumed in March but more revelations of false safety test records in June, this time at Toyota Motor itself, instead of its subsidiaries, are clouding the growth outlook for coming months.

Other details from the MOF’s Trade Statistics:

* Export volumes dipped 0.9% on year in May for the fourth straight drop after falling 3.2% in April while import volumes fell 1.9% after rising 0.7%.

* Exports to China, one of the top export destinations for Japanese goods, rose 17.8% on year in May for the sixth straight month after rising 9.6% in April. The increase was led by shipments of semiconductor-producing equipment, non-ferrous metals and plastics, largely as seen in recent months. The prices for copper among other non-ferrous metals have been rising, reflecting strong demand from China.

* Japanese exports to Asia as a whole also rose for the sixth consecutive month, up 13.6%, after rising 9.7% in April. The increase was led by solid demand for semiconductor-producing equipment, semiconductors and plastics.

* Exports to the U.S., which have exceeded those to China since October 2022, recorded their 32nd straight year-over-year rise, up 23.9% in May, after rising 8.8% in April and soaring 20.2% to a record high of ¥2.08 trillion in December 2023. The increase was led by automobiles and auto parts as well as drugs.

* Shipments to the European Union slumped 10.1% after falling 2.0% in April for first drop in five months and rising 3.0% in March. It was due to lower demand for automobiles, iron and steel as well as construction and mining equipment.

Source: MaceNews

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Warren Takunda

Economic

The Pound to Euro exchange rate lifted to 1.1860 after the ONS said the CPI services annual rate eased from 5.9% to 5.7% in May, but this was above the consensus expectation for a fall to 5.5%.

Money markets show investors lowered expectations for an August interest rate cut at the Bank of England as a result. OIS pricing shows expectations have slid to around 36% in the wake of these data, from around 55% the day before.

The Pound to Dollar exchange rate has risen to 1.2727 in response to the repricing in expectations. "GBP is slightly stronger, probably due to the hotter services CPI data," says Arno Venter at Capital Edge Advisors.

The good news for UK consumers and businesses, however, was that the UK's annual inflation rate finally fell to the Bank of England's 2.0% target. May's month-on-month figure reading was 0.3%, which is below the 0.4% the market was looking for.

Core CPI inflation was flat at 3.5% year-on-year, which is also what the market was looking for, so it won't be a market mover.

Although the fall in headline inflation to 2.0% will be welcomed, most economists agree inflation will creep up again over the coming months because services inflation is still too high.

As the 'base effect' of previous price rises falls out of the annual comparison, the sticky services print could mean inflation refuses to stay around 2.0%. This is why the Bank of England will not cut interest rates as early as tomorrow's meeting.

Pound Sterling Rallies Against Euro and Dollar: Services Inflation is Still Too Hot for the Bank of England_1

Above: GBP/USD (top) and GBP/EUR.

The key question for currency markets now is how these inflation figures impact the odds of an August rate cut.

Two members of the MPC voted for a cut already in the last meeting, and we reported on Tuesday that if one member - Dave Ramsden - withdrew his vote, the Pound would rise.

These inflation numbers could mean Ramsden sticks with his vote for a cut, and there is a risk others on the Monetary Policy Committee join him and Swati Dhingra. Pound Sterling Rallies Against Euro and Dollar: Services Inflation is Still Too Hot for the Bank of England_2

Pound Sterling Rallies Against Euro and Dollar: Services Inflation is Still Too Hot for the Bank of England_2

If this is the case, the odds of an August cut would rise, likely resulting in a softer Pound heading into the weekend.

"Finally! UK inflation fell to 2.0% in May, hitting the BoE’s target," says Julian Jessop, an economist at the IEA. "This was widely expected but still good news, and should make it much easier for more MPC members to join the two – Swati Dhingra and Dave Ramsden – who are already voting for a cut."

Nevertheless, caution will be abundant amongst other members of the MPC, as the Bank will have to address the sticky services inflation print and acknowledge that headline inflation could well creep higher again over the coming months.

Such caution would likely limit the scope of any GBP weakness and offer downside protection.

Food prices contributed the largest downward contribution to the change in annual inflation between April and May, while motor fuel prices contributed the largest upward contribution.

"Services inflation was a significant 0.4pp higher than the BoE had expected. This, along with strong wage growth and election-related near-term economic uncertainty, is likely to keep the BoE on hold when it announces its monetary policy decision tomorrow," says Marco Valli, Global Head of Research at UniCredit.

Source: Poundsterlinglive

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Thomas

Economic

He quickly ran into problems. The human resources department informed him that Japanese staff were afraid their neighbors would assume they'd been fired if they left home every morning dressed in casual clothes rather than the ubiquitous business suit. Innovation in Japan, brought a radical idea with him for his new colleagues: wear what you like at work.

Kuffner found a solution: lockers to let employees change out of their commute suits. But the consternation showcased a national work culture that in many ways can inhibit change. It was often said that Japan had the best economy for the 1980s: an emphasis on error-free, process-focused high-quality manufacturing. But supposedly not for a software-dominant 21st century that rewarded less linear avenues of thinking.

What's now becoming clear, however, is that a slew of structural changes have taken root in Japan—including cultural shifts that are opening up Asia's No. 2 economy in ways few would have expected a decade or so ago. "Animal spirits" may be taking root, enhancing Japan's appeal to investors and neighboring nations alike.

How some cultural conventions in Japan have held back progress has been widely explored. One example was the systematic manipulation of medical-school test scores in order to keep the number of female students down, out of concern women would work less for reasons including having children.

Discriminating against top performers based on gender stereotypes is hardly a recipe for success in any country. Japan's history of not being very receptive to foreigners has also been seen as a major restraint on economic growth.

In a developed nation where the fertility rate is far below the level needed to keep the population stable, preventing women and foreigners from joining the workforce is a recipe for disaster.

It took Japan's economic stagnation in the 1990s and 2000s to lay the groundwork for a shift in thinking on many fronts—from economic to defense to even social policies. And it gave traction to Shinzo Abe, the late prime minister who pushed for a wholesale rethinking of policy during a term that spanned almost eight years.

Japan's Sun Rises Again After Decades of Stagnation_1

Abe's shake-up included raising the role of women—dubbed womenomics. It was more than just a slogan: the prime-working-age female labor-force participation rate soared to a record of 74.3% by 2022, more than 10 percentage points above where it had trended before the advent of "Abenomics." (By contrast, the US rate has gone down.)

Abe's team also took steps to loosen rules on foreign workers—while minding the political sensitivity of change in this area. An analogy was made to baseball: when foreign players were given a limited entry into Japan's league, there was a public stir, but in time fans cheered on the non-native Japanese players. Perhaps the same could happen with attitudes toward immigration.

The result: last year, the number of foreign workers hit a record 2.04 million, up 12.4% from the year before. "Japan is entering an era of mass foreign immigration," said Junji Ikeda, who heads an agency that sources and supervises foreign workers.

Japan is also now luring a record number of foreign tourists, even though the number of Chinese visitors, the third-biggest group, hasn't recovered to pre-Covid levels. All those international visitors and workers will help to continuously open the country up.

The incorporation of and increasing respect for differences in Japanese society is manifesting itself in other ways as well. Japan's top business lobby, the Keidanren, this week urged the government to embrace letting married couples have separate surnames.

Last year, Japan's Supreme Court for the first time made a ruling on LGBTQ people's rights in the workplace, judging that it was illegal to restrict a transgender person from using certain bathrooms.

At a corporate level, Japan's legendary Ministry of Economy, Trade and Industry is offering major support for foreign companies' projects in Japan. Once known as MITI, the ministry was a mercantilist force in promoting domestic champions on the global stage starting in the 1950s.

Also emerging: a pushback against giant companies bullying their suppliers. The chair of Japan's main automaker association last month said change is afoot such that members will now accept the passing along of cost increases by their suppliers.

Another corporate change is the unwinding of cross-shareholdings of big Japanese firms, long seen by observers as reducing incentives for competition. Foreign executives for decades met with frustration in attempting to persuade Japanese customers to switch suppliers, as firms prioritized long-standing relationships with little regard to cost or efficiency.

All of these changes augur for a more flexible, more dynamic socio-economic backdrop for Japan that should provide major benefits in terms of productivity over time.

Source: Bloomberg

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Devin

Economic

With global growth stabilizing for the first time in three years, inflation reaching a three-year low, and financial conditions brightening, the global economy seems to be on its final approach for a "soft landing." But this positive news cannot obscure the grim reality: more than four years after the COVID-19 pandemic began, the world—especially developing economies—has yet to embark on a promising path toward prosperity.

As a new World Bank Group report shows, the rate at which annual global growth is stabilizing—2.7 percent, on average, through 2026—is significantly lower than the 3.1 percent average in the pre-pandemic decade. That is insufficient to support progress on key development goals. By the end of this year, one in four developing economies will be poorer than they were on the eve of the pandemic. In 2024-2025, most of the world's economies are set to grow more slowly than they did in the decade before COVID-19.

With global interest rates expected to average 4 percent through 2026, double the level of the previous two decades, this outlook is unlikely to change. Rather than hope for a stroke of luck, governments should be working to advance long-term growth by fostering productivity, entrepreneurship, and innovation, in a setting of closer international cooperation.

This is the model that flourished after the fall of the Berlin Wall. Encouraging the flow of goods, capital, and ideas across borders made possible roughly 25 years of unprecedented global prosperity, during which the gap between per capita income in the world's poorest and richest countries narrowed significantly. Before the pandemic, an end to extreme poverty appeared to be within reach.

But international cooperation has been fracturing in recent years. Measures designed to restrain cross-border commercial flows are proliferating. With many major economies holding elections this year, uncertainty over trade policy is higher than at any other moment this century. These developments are taking place amid persistent weakness in investment: in 2013 to 2023, investment growth in developing economies fell to less than half the rate in the 2000s.

This helps to explain why per capita income growth in developing economies is expected to average just 3 percent through 2026, well below the 3.8 percent average in the decade before COVID-19. Many developing economies will not make any progress at all in closing the income gap with their developed-economy counterparts in the near term, and that gap will widen for nearly half in the first five years of this decade—the highest share since the 1990s.

But there are also bright spots in the global economy. The United States, in particular, has shown impressive resilience, with growth remaining buoyant even amid the most rapid monetary policy tightening in four decades. U.S. dynamism is a key reason why the global economy has some upside potential over the next two years.

Among emerging markets, India and Indonesia stand out for their strong performance. Buoyed by vibrant domestic demand, surging investment, and a dynamic services sector, India's economy is projected to grow by 6.7 percent per fiscal year, on average, through 2026. (South Asia is now the world's fastest-growing region.) For its part, Indonesia is expected to grow by 5.1 percent, on average, over the next two years, thanks largely to a rising middle class and prudent economic policies.

These economies prove that high growth rates can be sustained, even under difficult conditions. If others want to achieve similar success, and enhance their own long-term growth potential, they must enact policies that strengthen human capital, boost productivity, and encourage more women to enter the labor force. To this end, efficient and well-targeted public investment is critical.

In developing economies, public investment accounts for just a quarter of total investment, on average. Our research shows that scaling it up by just 1 percent of gross domestic product (GDP) can increase total GDP by more than 1.5 percent over the medium term and boost private investment by as much as 2 percent within roughly five years. The benefits are largest in countries with a track record of efficient public investment and, crucially, sufficient fiscal space to increase spending.

For some countries, especially small developing countries with populations of less than 1.5 million, this is a formidable challenge. Home to just 17 million people, small developing countries face climate-related natural disasters at a rate that is eight times higher, on average, than in other developing economies. Making matters worse, two-fifths of these countries are in, or at high risk of, debt distress.

But this does not mean that small-state governments cannot steer their economies onto a more stable, prosperous path. On the contrary, they have considerable room to mobilize more revenues from domestic sources, which offer a more reliable fiscal base than foreign flows. They can also create fiscal frameworks—including rainy-day funds—capable of coping with frequent natural disasters and other shocks, and improve the efficiency of public spending, especially on health, education, and infrastructure. International policy coordination and financial support can complement these efforts.

Policymakers have good reason to celebrate: the world economy has avoided recession, despite the steepest rise in global interest rates since the 1980s. But they must also recognize that, in much of the world, growth remains too slow to support progress on development and poverty reduction. Without stronger international cooperation and policies that advance shared prosperity, the global economy will remain stuck in the slow lane.

Source: World Bank

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Devin

Economic

Stocks

As the far right and leftist parties gain momentum ahead of France's surprise parliamentary election, investors are starting to contemplate the risk of a budget crisis at the heart of the euro zone.

Marine Le Pen's far-right National Rally party (RN) is leading in opinion polls ahead of the ballot called by President Emmanuel Macron for June 30 and July 7, albeit unlikely to win an absolute majority.

Although it has not yet announced its detailed programme, the RN has previously favoured lowering the retirement age, tax cuts and boosting spending.

That has exacerbated concerns about fiscal sustainability in the euro zone's second largest economy just weeks after France's high deficit led to a credit rating cut.

A newly formed leftist alliance meanwhile said on Friday it wanted to lower the retirement age and tie salaries to inflation, adding to expectations for higher spending under a new government. Polls show the leftist parties coming second behind the RN.

Investor reaction was blunt: the risk premium they demand to hold French government bonds over euro zone benchmark Germany rose to the highest since 2017 on Friday at 82 basis points, its biggest weekly jump since at least 2010, according to LSEG data.

On Monday it dropped to 75 bps as markets calmed, but was still over 25 bps higher than before the election announcement.

"The focus has shifted back to the scope for some kind of near term crisis," said Gordon Shannon, portfolio manager at TwentyFour Asset Management.

"You're pricing the risk that you have an event similar to the UK's mini budget," he said, referring to Britain's then-Prime Minister Liz Truss' mini-budget of unfunded tax cuts in 2022 that pummelled gilts and forced the Bank of England to step in to stabilise markets.

Finance Minister Bruno Le Maire, urging voters to back Macron's centrist candidates, warned on Friday of the risk of a financial crisis if either the far right or the left wins the election.

The cost of insuring France's debt against default jumped on Friday to its highest level since May 2020, while the spillover of rising borrowing costs has knocked banks.

Shares in the country's biggest three - BNP Paribas, Credit Agricole and Societe Generale - struggled to recover on Monday after losing between 11-15% last week, the most since March 2023's banking crisis.

But the European Central Bank's chief economist Philip Lane on Monday downplayed any need for the ECB to come to France's rescue by buying bonds, saying the market moves were not disorderly, a condition for ECB intervention.

ECB sources had earlier told Reuters policymakers had no plan to discuss emergency purchases of French bonds and thought it is for French politicians to reassure spooked investors.

The ECB's backstop tool to buy government bonds if warranted requires compliance with parameters like the EU's fiscal rules to limit budget deficits.

Euro zone reckoning?

Demonstrating how market ructions are already hitting funding plans, a French state-backed agency cancelled a bond sale and France's treasury plans to raise a smaller amount than usual at a bond auction this week.

Bond investors are often dubbed vigilantes by analysts for demanding higher returns from governments they perceive as fiscally reckless.

"We've already had a stress test in the UK with the mini budget and we had a bit last summer in the U.S. when Treasury yields rose sharply after the Treasury refunding announcement," said Guillermo Felices, global investment strategist at PGIM Fixed Income.

"We haven't had this yet in the euro zone."

The Institut Montaigne think tank has said the RN's programme for the 2022 parliamentary election would cost more than 100 billion euros -- suggesting a 3.5 percentage-point increase in France's budget deficit -- if fully enacted. That's much higher than estimates for Truss's tax cuts.

RN President Jordan Bardella said on Friday that the party would detail its platform in the coming days and how it would be financed. It has so far been vague about where it stands on fiscal responsibility, other than blaming the outgoing government for straining the public finances.

"In an extreme case, the risks could include a Liz-Truss-style blowout in yield spreads," Holger Schmieding, chief economist at private bank Berenberg, said earlier this week.

Britain's 10-year yield jumped over 100 bps in less than a week during its budget crisis.

There were some early signs that concern over France might spread in the euro zone.

Italy's closely-watched risk premium over Germany rose to the highest since February at 159 bps on Friday.

Italy last year posted the highest budget deficit-to-GDP ratio in the European Union, at 7.4% of output. Together with France, it is expected to face a European Union excessive deficit procedure requiring it to reduce its structural deficit.

The euro hit a 1-1/2-month low against the dollar on Friday and euro zone bank stocks fell 8% last week.

Others said it had yet to be seen how a potential government that included the RN would act in office. Italy's debt outperformed last year, helped by far-right Prime Minister Giorgia Meloni moderating her tone in office.

Iain Stealey, international chief investment officer for fixed income at JPMorgan Asset Management, said the RN's spending plans would be curbed by the EU's deficit rules.

"The market will also be a key force in keeping National Rally in check, with the party likely to take a more prudent fiscal stance ahead of the 2027 presidential election," he added.