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Reflections on France after the elections



This article is an on-site version of Martin Sandbu’s Free Lunch newsletter. Sign up here to get the newsletter sent straight to your inbox every Thursday

France hurtled into a new political era on Sunday, when voters returned a national assembly in which no party holds a majority. It was an unexpected rebuff to President Emmanuel Macron who had just won a second term in power. Having just spent a few days in Paris, here are some of my reflections on where the country finds itself — economically and politically.

Like everywhere else, the big economic challenge is the cost of living crisis in a situation of slowing growth — indeed, the French economy contracted in the first quarter of this year. Some expect a recession by the end of 2022.

If rising prices were behind the government’s disappointing election result, it could be forgiven for feeling undeservedly punished by voters. On some measures the French economy is doing exceedingly well: unemployment is historically low and labour market participation is at a record high. A lot of this should be credited to the labour market policies that were the great achievement of Macron’s first mandate (reforming labour law, boosting apprenticeships for the young, spending on active labour market measures). But the government is a victim of its own success; if the problem of joblessness seems largely solved, voter attention has moved elsewhere.

Even the cost of living is going up less in France than in other countries — it had the lowest headline and core rates of consumer price inflation in the eurozone in May (5.8 and 3.4 per cent). This, too, is due to policies — in particular a heavy-handed cap on household energy prices below market level, at a very high cost to the public finances (there is also a fuel discount). I have written before about why a better approach would be to make direct support payments to households that need help, while letting the market price mechanism do its job. To be fair, France does this too (through its chèques énergie) and the temptation to go against the grain of the market is hardly unique to the country. And it is understandable that politicians may choose what works politically over what makes sense economically.

Except that, like the success on jobs, the money spent on keeping energy prices low may not have worked politically — at least not enough to deliver a parliamentary majority. (Although it possible Macron’s parliamentary alliance would have done even worse in the election had not enough people recognised its economic achievements.)

In any case, a new cost of living package is expected; the government has promised one in the campaign and was scheduled to pass one to extend current support provisions in the next few weeks. That is likely to be the first casualty of a splintered parliament (unless it is Prime Minister Élisabeth Borne, whose longevity in office is now an open question). One French economist remarked to me that you can always get politicians to agree on spending more money. But there is so much acrimony against Macron that even this seems hard.

This brings us to the politics proper. It is quite a moment for the Fifth Republic and, in particular, for its majoritarian electoral system. Like the UK’s first-past-the-post, the French system of second-round run-offs has tended to favour the big traditional parties and keep challenger parties out of the legislature. This has produced consistent parliamentary majorities — even if sometimes for the party opposed to the president. The lack of a governing majority has raised the question of whether France is now ungovernable.

But both French and outside commentators ought to recognise how much this outcome would be an artifice of an electoral system that generates expectations of absolute majorities — expectations that may be unrealistic in a world where voters do not congregate to two main party groupings. In countries with proportional voting systems, absolute majorities for a single party are unheard of, so coalitions or minority governments are the norm. And in such systems, a result of 38.6 per cent — which is the share Macron’s alliance achieved in the second-round vote — would be a huge victory, especially after five difficult years in power. My own sense is that France has joined the US and the UK in proving how ill-fit majoritarian electoral systems are for the 21st-century political landscape, compared with the proportional systems most of Europe uses.

As the president himself said in a speech to the nation on Wednesday night, Germany and Italy routinely operate without absolute majorities. The question is which of these two examples, if any, ends up guiding him and France’s newly elected parliamentary leaders as they chart a course forward: orderly and committed coalition negotiations as in Germany, or successions of weak governments as in Italy (or indeed France’s own 1950s experience with the Fourth Republic)? The signs are not too promising: “I don’t have a German inclination,” huffed the leader of the rightwing Republicans. But at least options such as a national unity government and case-by-case coalition-building are being discussed, and an awareness is developing that winner-takes-all politics can be a liability for the country.

There are echoes here of the UK’s unruly parliament between 2017 and 2019, which should make French politicians redouble their efforts at cross-party co-operation. The alternative is, as then in the UK, a snap election. Behind all the manoeuvring hovers Macron’s power to dissolve the national assembly at a time of greatest electoral convenience. That is what Boris Johnson did in December 2019. We know how well that went. France should prefer to use this opportunity to build a more collaborative political culture.

Other readables

  • Today EU leaders are expected to make Ukraine a formal candidate for membership of the bloc. This has depended on France relaxing its resistance to enlargement, which it long saw as being in tension with its aim of making the EU more decisive and forceful. In my FT column this week, I argue that Ukraine shows these goals are not in tension. Quite the opposite: a genuine commitment to getting Ukraine ready for membership is what will most strengthen the EU’s ability to shape the world stage.

  • Robert Armstrong and Ethan Wu have an excellent discussion (in their Unhedged newsletter, which is well worth signing up to) of how much falling stock and crypto prices may reduce US economic activity — as much as 2 per cent in their back-of-the-envelope calculation.

  • Mike Rogers, a former member of the US Congress, calls for a digital Bretton Woods — norms to govern the digital global economy. Without this, he argues, the rules will be shaped by China, whose new electronic currency is designed to unseat the US dollar’s global dominance.

  • The Washington Post explains why, at a time of record-high prices for petrol products, US refineries are closing down. Are there any experts among Free Lunch readers who can tell us what the situation is in the European refinery business?

Numbers news

The Lex Newsletter — Catch up with a letter from Lex’s centres around the world each Wednesday, and a review of the week’s best commentary every Friday. Sign up here

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US blacklists Chinese companies for allegedly supporting Russian army



The Biden administration has placed five Chinese companies on an export blacklist for violating sanctions by allegedly providing support to Russia’s military and defence companies before and during the invasion of Ukraine.

The commerce department put the Chinese firms on the “entity list”, which effectively bars US companies from exporting to them. The companies, which are not globally recognised names, are Connec Electronic, King Pai Technology, Sinno Electronics, Winninc Electronic, and World Jetta (HK) Logistics.

“Today’s action sends a powerful message to entities and individuals across the globe that if they seek to support Russia, the US will cut them off,” said Alan Estevez, under-secretary of commerce.

The blacklisting was announced as the US grows increasingly worried about strengthening ties between Beijing and Moscow, particularly after Xi Jinping and Vladimir Putin in February signed a statement that described the China-Russia partnership as having “no limits”.

The Financial Times reported in March that China had signalled a willingness to provide military assistance to Russia, which set off alarm bells in Washington.

Over the past two months, Jake Sullivan, US national security adviser, and Lloyd Austin, secretary of defence, have warned their Chinese counterparts that Washington would take strong action if China gave Russia any military equipment or assistance. US officials said there was no evidence that China has provided military assistance.

The commerce department did not accuse the Chinese government or military on Tuesday of supplying equipment to the Russian army. “We have not seen China provide Russia with military equipment or systematic evasion of sanctions,” said a White House official.

But the decision to place the companies on the entity list emphasised the broader concern about ties between China and Russia. It also marked the first time that President Joe Biden’s administration has penalised Chinese entities for helping the Russian military since Putin launched the invasion of Ukraine in February.

Chinese and Russian nuclear bombers flew over the Sea of Japan last month while Joe Biden was in Tokyo, further stoking US anxieties. Experts said the exercise highlighted how Beijing was co-operating with Moscow even as Russian forces waged their assault on Ukraine.

The Chinese embassy in the US said Beijing was playing a “constructive role” in promoting peace talks and had not provided military assistance to Russia.

“China and Russia maintain normal energy and trade co-operation, and the legitimate interests of Chinese companies should not be harmed,” said an embassy spokesperson, who criticised Washington for imposing unilateral sanctions under its “long-arm jurisdiction”.

Follow Demetri Sevastopulo on Twitter

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Value in the short(er) end



This article is an on-site version of our Unhedged newsletter. Sign up here to get the newsletter sent straight to your inbox every weekday

Good morning. Ugly day for stocks yesterday. The blame was pinned on a bad reading on the Conference Board’s consumer confidence index. Feels more like a market looking for an excuse to sell, though. And for good or bad, the market half-life of economic data is measured in hours at this point. Email us with measured, sensible, long-term views: and

Value in short end credit?

Working on yesterday’s letter about long-maturity corporate credit, I chatted with Jim Sarni, a principal at Payden & Rygel, a good friend of Unhedged. He pounded the table a bit, saying that I had things backwards: the real opportunity was in the short to middle bit of the curve.

“It’s appealing from the simple standpoint of, where the hell do I put my money right now, whether as an institution or a private investor,” Jim says. “And it can appeal no matter what view a person has — that we are facing Armageddon, or we are going to be fine.”

The argument goes like this. A portfolio of investment-grade corporates with an average duration around 2.5 years provides a yield of up to 4 to 4.5 per cent. “Doing the math on the back of a napkin,” Sarni says, “that means Treasury yields can move up another 180 basis points or so before total return to the investor turns negative.” 

The two-year Treasury, roughly mirroring the expected peak for the fed funds rate, is yielding 3.1 per cent. Suppose that does move up to, say, 4.6 per cent. Now your basket of mid-duration corporates are barely at break even. But under those circumstances, equities and longer-duration bonds will probably be doing a lot worse than break even. Losing only a little money might have you feeling pretty good. And if rates fall (or spreads tighten), there will be bonus returns along the way.

CPI, of course, is running at 8 per cent or so, which makes a yield of half a lot less enticing. Sarni is undeterred: “You’ve gotta be somewhere. Eight per cent is not a long-term number. It’s 8 per cent coming down. Over the duration of this portfolio inflation won’t be close to 8 per cent — north of 3, south of 4, maybe?” Sarni thinks that, given the palpable slowing in the economy when the Fed is only halfway to its anticipated destination, the bet is tilted towards lower inflation and rates. And if the Fed pushes the economy into a hard landing, you could do worse than owning the debt of companies “that are going to weather the storm just fine”.

For a proxy of the kind of portfolio that Sarni is talking about, you can look at, for example, the Ice BofA 1-5 year corporate ex-144a index (yield to worst 4.25 per cent, average duration 2.7 years); or the Bloomberg US corporate bond 1-5 year index (yield 4.33 per cent, duration three years). Here is the price and spread of the latter over the past year:

Keen to hear from our readers in the bond business whether they also see value in this bit of the curve.

After 60/40, redux

We’ve been asking around these parts what the next 60/40 portfolio — 60 per cent stocks for growth, 40 per cent bonds for stability — should look like if we are moving into a world of persistently higher inflation. In such a world, the glorious negative correlation of bonds and stocks of the last 30 years or so may be nothing but a memory.

We call this replacement, affectionately, the dumb portfolio. It has to generate decent returns over a long horizon, require little active oversight and can’t be too complex. There also have to be enough assets for a broad swath of investors to pile in. Inflation-linked I-bonds, for example, have less than $60bn in circulation. They don’t fit.

We noted last time that commodities looked better as an inflation hedge than as a way to grow capital. A few readers pointed out that we used an index that understates how well commodities have done by focusing only on raw price performance. They rightly suggested we try a total return index instead, which includes the extra yield earned by the collateral, usually Treasury bills, that must be held against commodity futures. The difference is noticeable:

Line chart of Bloomberg commodity indices showing Not as bad

Still, this is not a resounding growth story. The latest rally puts us back to early 2000s levels. The last sustained period of appreciation before that, from the early 1980s to early 2000s, saw commodities grow 531 per cent, versus over 2,000 per cent for the S&P 500. Unless you believe a commodity supercycle is coming (lots of people do!), expect a growth trade-off for the diversification benefit.

Another possibility is publicly listed infrastructure projects. Tim Robson, spooked by inflation a year ago, wrote that he cut out his 35 per cent bond allocation to add infrastructure and has liked the results:

This construct has performed as I hoped with significant gains and yield from this infra allocation offsetting my equity losses since the turn of the year.

In the UK this shift was relatively easy to achieve by buying a selection of UK listed infrastructure investment trusts.

Several readers suggested getting exposure to factors such as value or momentum. Here’s Caleb Johnson, formerly at AQR and now at Harbor Macro Strategies:

Investors don’t just need exposure to more asset classes, like commodities, they need exposure to factor and style premia. Yes, this has typically been available mainly through private investments . . . but they are also available through “liquid alts” in the form of mutual funds and [exchange traded funds] that non-accredited investors can access as well.

Consider a style factor like momentum. A commodities ETF treats an entire asset class like a monolith and is only going to give an investor passive exposure to it. But a factor-oriented fund is going to do more than offer long-only exposure, allowing investors to profit from exposure to individual markets across asset classes even when they are going down in price.

Along similar lines, Philip Seager at Capital Fund Management wrote that trend following, factor investing’s close cousin, looks promising:

Not only is it a diversifier (on average zero correlated with equities) but also has mechanical features that make it a hedge against long, drawn out, protracted moves down in equities (see the 2008 crisis for example). We have also shown recently that TF as applied to commodities provides an effective hedge against inflation (end 2021 and 2022 year-to-date demonstrate this). On top of all this because of its long term nature and exposure coming from very liquid futures contracts it also scales very well.

We don’t deny the proven power of trend following and factor investing (when done right) but wondered whether the underlying concept might be too complex, even if you can buy it in an ETF. In general, the point of the dumb portfolio is maximum returns given minimum trust in your fund manager. Factor investing asks for a lot of trust.

Paul O’Brien, a 60/40 optimist, suggested a simpler change:

The key premise of the 60/40 is not the negative correlation of stocks and bonds. It is the low covariance of stocks and bonds. Bonds are less volatile than stocks and so will diversify a stock portfolio (lower portfolio volatility) even if the correlation is [positive].

Rather than ditching the 60/40, investors may want to hold lower-duration bonds, or [Treasury inflation-protected securities].

Could building the inflation-proofed dumb portfolio be as easy as take 60/40, sprinkle in some Tips and small caps, and call it a day? (Ethan Wu)

One good read

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The risk of a flip-flopping Fed



The writer is president of Queens’ College, Cambridge, and an adviser to Allianz and Gramercy

The markets are evolving their minds about US economic prospects just as the Federal Reserve has been scrambling again to catch up to developments on the ground.

This risks yet another round of undue economic damage, financial volatility and greater inequality. It also increases the probability of a return to the “stop-go” policymaking of the 1970s and 1980s that exacerbates growth and inflation challenges rather than addressing them.

Good central bank policymaking calls for the Fed to lead markets rather than lag behind them, and for good reasons. A well-informed Fed with a credible vision for the future minimises the risk of disruptive financial market overshoots, strengthens the potency of forward guidance on policy and provides an anchor of stability that facilitates productive physical investment and improves the functioning of the real economy.

Coming into the second half of June, the Fed had already lagged behind markets twice in the past 12 months and in a consequential manner. First it stubbornly held on to its “transitory” mischaracterisation of inflation until the end of November, thereby enabling the drivers of inflation to broaden and become more embedded. Second, having belatedly course-corrected on the characterisation, it failed to act in a timely and decisive manner — so much so that it was still injecting exceptional liquidity into the economy in the week in March when the US printed a 7 per cent-plus inflation print.

These two missteps have resulted in persistently high inflation that, at 8.6 per cent in May, is hindering economic activity, imposing a particularly heavy burden on the most vulnerable segments of the population, and has contributed to significant market losses on both stocks and government bonds. Now a third mis-step may be in the making as indicated by developments last week.

Having rightly worried about the Fed both underestimating the threat of inflation and failing to evolve its policy stance in a timely manner, markets now feel that a late central bank scrambling to play catch-up risks sending the US economy into recession. This contributed to sharply lower yields on government bonds last week just as the Fed chair, Jay Powell, appeared in Congress with the newly-found conviction that the battle against inflation is “unconditional”.

The markets are right to worry about a higher risk of recession. While the US labour market remains strong, consumer sentiment has been falling. With indicators of business confidence also turning down there is growing doubt about the ability of the private sector to power the US economy through the major uncertainties caused by this phase of high inflation.

Other drivers of demand are also under threat. The fiscal policy impetus has shifted from an expansionary to contractionary stance and exports are battling a weakening global economy. With all this, it is not hard to see why so many worry about another Fed mis-step tipping the economy into a recession.

In addition to undermining socio-economic wellbeing and fuelling unsettling financial instability, such a mis-step would erode the institutional credibility that is so crucial for future policy effectiveness. And it is not as if Fed credibility has not been damaged already.

In addition to lagging behind economic developments, the central bank has been repeatedly criticised for its forecasts for both inflation and employment — the two components of its dual mandate. A recent illustration of this was the sceptical reaction to the Fed’s update on monetary policy released on June 15.

The scenario that worries the market — the Fed aggressively hiking rates only to be forced to reverse by the end of this year due to the threat of recession — is certainly a possibility, and it is not a comforting one.

There is another equally possible alternative, if not more likely and more damaging economically and socially: A multi-round flip-flopping Fed.

In this scenario, a Fed lacking credibility and sound forecasts would fall in the classic “stop-go” trap that haunted many western central banks in the 1970s and 1980s and remains a problem for some developing countries today lacking policy conviction and commitment. This is a world in which policy measures are whipsawed, seemingly alternating between targeting lower inflation and higher growth, but with little success on either. It is a world in which the US enters 2023 with both problems fuelling more disruption to economic prosperity and higher inequality.

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