Executive Summary

• All Politics is Local: Growth, immigration and social programs drive elections
• Despite election turmoil, support for Ukraine in the UK and France seems enduring
• Weak coalitions combined with a lack of patience from voters may result in moves to the center and possibly more government turnover in the next months to a year

The United Kingdom Ends 14 Years of Conservative Rule

The issues underpinning the conservative party’s defeat are unremarkable and expected. Despite years of public dissatisfaction, the government was unable to make substantive improvements in cost of living, improving public services and stemming high immigration in the UK. Living standards have fallen after two years of high inflation fueled in part by Russia’s war in Ukraine, which sent energy prices soaring. Compounding these issues are high debt and high interest rates on that debt necessary to keep the economy from collapsing during COVID and deal with 2022 energy price increases.

In the UK, the government’s energy price cap (the maximum amount that can be charged per year) increased by 12% in October 2021, 54% in April 2022 and 80% in October 2022 (gas by 91%, electricity by 70%). The caps move quarterly on domestic energy but even given some of the ups and downs, energy prices are still 27% above the summer 2022 cap. Gas was 37% higher than in summer 2022, while electricity 17% higher.[1] Adding to the debt (assuming no tax increases) the Conservative Government of Liz Truss (remember her?) in 2022 paid energy suppliers some of the difference in energy production costs and the price caps. Combined with her libertarian economic policies, her decisions triggered a financial crisis which required emergency central bank intervention, multiple U-turns and the firing of her Treasury chief…all in about 6 weeks of rule as PM. One Conservative lawmaker, Robert Halfon, growled that in a few weeks the Truss government created “one horror story after another.” As if “libertarian jihadists treated the whole country as (sic) laboratory mice on which to carry out ultra, ultra free-market experiments,”[2] After not quite two years as PM, Rishi Sunak was unable to correct the downslide.

Fueled by historically low voter turnout of only 60%, Labour won 412 seats, an increase of 211, while Conservatives lost 250 lawmakers, including a record number of senior ministers. This loss is worse than the defeat suffered by Winston Churchill in 1945 when Labour won 393 seats as Churchill’s policy platform of lowering taxes, maintaining defense spending and providing an environment for business growth was rejected in favor of government direct action on social reform. Only Tony Blair’s Labour Party has ever won more seats in an election. Starmer has promised to rebuild public services, cut energy costs and secure the border. He has also said he will keep defense spending at 2.5% of GDP, 0.5% above the NATO minimum standard. He is pro-business, pro-growth (both indicators of a movement from the left to the center) and will likely have a honeymoon measured in days or weeks instead of months.

The implications of this election on global security will be seen more clearly in NATO summit discussions and other public statements. Support for Ukraine is likely to continue as Starmer and the British person in the street understand the threat posed by a resurgent Russia better than the average American. The new defense secretary, John Healey and the new foreign secretary David Lammy have unequivocally said that the commitment to Ukraine will be “iron-clad”.[3] How they balance social service reform, government spending on things like energy subsidies and defense, the labor shortage and immigration policies will indicate the actual priorities of the new government.

French Elections More of a Surprise

The French election surprises over the past month are more complex, but similar to the outcome in the UK. President Marcon seemed on his way completely out after the first vote, yet managed to forge a victory of sorts as French voters ultimately rejected the far-right party of Marine Le Pen. In the first ballot, the far right tapped into voter frustration with inflation and low incomes with a message that many French families are being left behind by globalization. The National Rally (RN) party campaigned on promises to raise consumer spending power, slash immigration and take a tougher line on European Union rules. However, its anti-immigration agenda resulted in many French citizens with immigrant backgrounds feeling unwelcome in their own country. In the final vote, the RN party won more National Assembly seats than ever, but was kept from actual power by voters who still don’t believe far-right policies should govern France. Lingering distrust from Le Pen’s father’s party on issues like racism, antisemitism and the country’s still painful World War II history past of collaboration with Nazi Germany also played a role.[4]

Current media analysis is focusing on the tactics used by Macron to ensure the far-right party did not take power, opting instead for multi-party rule. The result will likely be coalitions on various policies that include different ideological points of view. For example, Macron passed a 2022 law to increase the retirement age to 64 (from 62) but he may see a move to reverse that law from the left wing New Popular Front (NPF) which secured 188 seats (an increase of 57) as well as from the far-right National Rally (RN). Rolling back pension reform is fiscally risky for the government.However, when it comes to support for Ukraine, the center party of Macron will get support from Green and socialist MPs as well as some in the conservative Les Republicains party. On energy policy, a multi-party coalition may form around continuance of nuclear power as currently deployed as well as doubling down on renewable energy, particularly hydraulic power. Disagreements over economic and foreign policies are likely, as the NFP’s unrestrained spending plans, including raising the minimum wage, foods and energy price caps and reversing Macron’s pension reforms will collide with the European Union’s restrictive fiscal rules and France’s need to rein in its ballooning deficit. The annual deficit in 2024 is predicted to be 5.3% (5.5% in 2023), with a total debt of over 112% of GDP. These indicators have triggered action from the EU. The EU executive’s decision in June to launch the “excessive deficit procedure” against France both hurts and supports Emmanuel Macron and some of his policies. France’s deficit is well above the EU threshold of 3% which sets up a clash between the EU and any coalition.

Agreed to last year, rule-breaking EU countries must reduce “excessive” deficits by 0.5% a year. But the rules allow some flexibility for spending on defense, green and digital policies This means gridlock is a likely outcome in the immediate future (up to a year until new elections can be called) with some threat of EU sanctions. However, no nation in the EU has ever been fined as this step could worsen an already bad situation. The French budget submission to the EU in October will indicate what priorities the new multi-coalition government believes are possible.

In short, the French will continue to try to find some progress on budget issues while supporting Ukraine and helping their economy to grow. There will be proposals from all sides which may cause short term consternation in the markets until compromises are enacted, in some form, by various finicky minority parties, or invocation of constitutional mechanisms (Article 49.3 allows passage of a law without a vote in the National Assembly unless they pass a vote of no confidence in the government[5]). Given the lack of a majority for any party, time will tell if a vote of no confidence is the only thing they can all agree on.

The Bond Vigilantes Are Not Only Back, But Inspired

The saying goes that elections have consequences. Global pandemics do as well. After years of zero and negative interest rates, quantitative easing, and central bank bond buying, we are not only experiencing the impact of a higher rate structure around inflation but the ensuing implications of excessive borrowing globally. Deficit spending is alive, but it is not well. The narratives come and go even when you look at the issues here in the United States.

The decision of French President Emmanuel Macron to call a snap election ended with results that were unexpected and has led to uncertainty and increased yield spreads between French and German debt. It is a logical response from markets. The core focus on Germany and expectations moving forward as the new government forms in France of continued volatility and a higher premium for French debt. This is not a crisis.

France is running deficits of 5% to GDP and debt around 110%. Demands from the European Union are clear and will need to be met. In the United States we are running deficits of $2 trillion per annum despite economic conditions that remain reasonable. Unprecedented without a crisis or war. But one government, currency, and reserve status has given us a short-term pass. But over time this will not be a “free” pass as central bank bond buying and zero interest rate policy no longer behave as a backstop. Overall, The USD has remained steady. When you move interest rates around in this environment because of inflation, interest rate differentials matter. But so too capital flows and fiscal confidence. We do not want to take for granted this pocket of forgiveness in the United States. Japan is learning a lesson that currency intervention does not work in a global macro pocket like this.

We are amidst one of the most powerful dissections of monetary and fiscal policy. The mood can change quickly when we look at the fiscal and sovereign side of the ledger. Ultimately, we tend to gravitate toward monetary outcomes because they are easier to model. For context, in 2022, the UK battled issues around unfunded tax cuts. The bond market was very quick to react and punish, and the Bank of England stepped in to quell the waters. We had a similar, watered down move in US markets in 2023, as we emerged from the debt ceiling debate and long end US Treasury yields broached 5% with increasing term premium.

Below is the chart of term premium in the US. An obvious decline when the Fed and other global central banks were at ZIRP and expanding their balance sheets. The spike in the United States was noticeable in October of 2023 and quickly met by Chair Powell’s late year pivot. Term premium model: ACM: Adrian, Crump, & Moench.

What’s Important for Markets?

1) Governments around the world have been able to borrow through decades of negative and zero interest rates. At the same time central banks buying bonds and expanding balance sheets. The debt we have accumulated is now crowding out private investment at higher interest rates. It is not being discussed enough in the US but regardless of who sits in the White House come January of 2025 it will not be as easy to spend. Numbers do not lie and these events, France included, will impede potential real economic growth.

2) Interest rate markets are very free to trade and express opinions with the inflation genie out of the bottle. At the same time, consumers and voters are very disturbed at the higher cost structure since the pandemic. Further government spending only makes the inflation dynamic worse, and we are seeing this front and center in the US. True, the “rate of change with inflation has subsided” but the overall cost structure remains high. There is a great deal of emotion in the electoral process right now and understandably so.

3) Political outcomes will continue to make central bank policy difficult. The supply side of the global economy will remain paramount. Not all governments are created equal by recognizing the will of the people. Central banks around the world have been in charge for quite some time. And that dynamic has shifted. To the extent the electoral process remains uncertain and volatile so too will monetary policy.

4) Do not underestimate the election in the US and implications globally. It has been extremely difficult to extrapolate in this environment. The former President is very keen on the supply side of the economy. And that remains the hiccup with inflationary pressures. Spending without supply leads to inflation. The Fed has been effective in slowing the “rate of change.”

5) Markets can exist quite effectively with higher rates. It’s healthy. Searching for that “neutral rate” takes time. There is no science. But we will get there. It will require over time what we are seeing from central banks and more important the voice of the people.

6) Be aware: The Global Bond Vigilantes are back. It is needed to keep our global fiscal spending in check.

About Michael Snodgrass

Michael Snodgrass retired from the U.S. Air Force as a Major General in 2011. He is currently the President of SG Strategic Solutions LLC.

He has extensive command and leadership experience in the U.S. Air Force and joint world, as well as a wide range of disciplines, including defense and aerospace, technology development, government acquisitions and requirements, foreign military sales and leadership coaching.

He consults with the government, defense industry and other businesses on a wide range of topics. In 2019 he became an adjunct contract professor supporting the U.S. Air Force on strategy and policy development.

From 2014 to 2016 he was Vice President, International Business Development at Raytheon Corp. Prior to that he was Director of U.S. Air Force and Federal Aviation Administration programs at Engility Corp.

General Snodgrass joined Burdeshaw and Associates in 2012 and is a Senior Consultant for numerous clients in the defense and aerospace sectors. Prior to his retirement, he was U.S. Air Force Assistant Deputy Under Secretary for International Affairs; responsible for formulating and executing USAF Policy, Strategy and Programs for Building Partnerships and integrating Air Force policy with international partner goals, totaling over $40 billion total program value.

From 2007 to 2010 he served as the first Chief of Staff, U.S. Africa Command. There, he was responsible for the construction of the country’s newest Unified Geographic Command.

He has commanded at the squadron, group and wing levels and has lived in/visited over 50 nations while in uniform. He has over 3500 flight hours in various aircraft including the F-16, F-15, F-4, C-130 and HH-60, as well as over 100 combat missions in Operation Desert Storm.

In addition, General Snodgrass teaches leadership and management courses. In his spare time, he provides leadership coaching and training to the U.S. Air Force ROTC unit at Florida State University.

About Gregory Faranello, CFA

Gregory Faranello has 25 years of experience in the financial services industry, which has been centered around fixed income with a core expertise in the trading, distribution and business development of global interest rates.

Prior to working at AmeriVet, Mr. Faranello served as Head of Rates for Roberts & Ryan Investments, Inc.

His career began as a fixed income derivative analyst with Credit Suisse, Merrill Lynch and Goldman Sachs.

Following Goldman Sachs, Mr. Faranello moved to the buy-side as an assistant portfolio manager on the international bond desk with Deutsche Bank Asset Management.

In a move back to the sell-side, Mr. Faranello filled leadership roles as Managing Director and FICC management member for RBS Greenwich Capital, WestLB, Espirito Santo, and RBC serving as head trader and risk manager responsible for the build-out and development of several trading desks.

Mr. Faranello attended the U.S. Military Academy at West Point and later earned his bachelor’s and master’s degree in business administration from Hofstra University in banking, finance and international business.

Mr. Faranello is a CFA Charterholder and member of the CFA Institute, NYSSA, Money Marketeers of NYU, and has served on the Dean’s Advisory Board of Hofstra University’s Zarb School since 2012.

Additionally, he is registered with his FINRA Series 7 and 63.

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[1] See: https://commonslibrary.parliament.uk/research-briefings/cbp9491/#:~:text=Typical%20household%20energy%20bills%20increased,their%20winter%202021%2F22%20levels.

[2] See: https://apnews.com/article/health-business-london-covid-economy-a3ab83f5a9eb2dcae0dc6a85dba86338

[3] See: https://www.bbc.com/news/articles/c0veg88g7jyo

[4] See: https://apnews.com/article/france-elections-le-pen-antisemitism-macron-5c4c8fa261b0fa2f2e35c14c072a60b4

[5] See: https://www.lemonde.fr/en/france/article/2022/10/19/france-how-does-article-49-3-allow-a-bill-to-be-passed-without-a-vote_6001019_7.html

Learn more about the author, Advisory Board member and retired U.S. Air Force Major General Michael Snodgrass.