Budget stand-offs in the US and in France are fuelling political tensions. The US dollar is gaining ground as French budget woes dent the euro.
Talks between the Republican and Democratic camps remained deadlocked as they failed to reach an agreement to keep the government funded. As the impasse in the Senate continued and efforts to secure a qualified majority were unsuccessful, non-essential government services shut down on 1 October. Democrats voted down the Republicans’ stopgap proposal to extend the current budget to the end of November, insisting that any funding deal must include an extension of healthcare tax credits and subsidies.
Meanwhile, 750,000 federal workers face being temporarily laid off as the most direct consequence of the budget paralysis. The Trump administration also announced it is temporarily freezing funding for infrastructure projects – mainly in blue states. The markets are also feeling the effects. The Bureau of Labour Statistics (BLS) was unable to publish its monthly jobs report at the start of the month, leaving investors in the dark. Remember, the markedly weaker job creation numbers over recent months were behind the shift in monetary policy in September, prompting the first rate cut by the Fed since the beginning of the year.
Shutdowns have happened before. Since the mid-1970s, the US has had more than 20 funding stand-offs that partially shut down the government. At 35 days, the longest was during Donald Trump’s first term. Fortunately, they generally have little direct negative impact on the economy. Shutdowns cost around 0.1% of GDP per week and are followed by a significant rebound when the government reopens and workers receive their back pay.
Yet the massive layoffs announced by the Trump administration, affecting more than 4,000 workers, and the continued deadlock over government funding could not only weaken the economy further but also create more significant second-round effects on business and consumer confidence.
Political risk is also mounting in the eurozone, driven by the political instability that has roiled France since the dissolution of parliament in June 2024. No sooner in place, the country’s fifth government in the space of 15 months – Lecornu II – already appears shaky. The new team’s number one goal is to draw up and pass a budget for 2026. It’s a complex task. In a National Assembly where no one party has a majority, the new government must set out a credible path to reducing the deficit, but without hampering growth.
France has a gaping hole in its public finances. The primary balance, the fiscal balance before interest expense, has been firmly in negative territory since 2001. Its debt pile has spiralled and hit 113% of GDP in 2024. With public spending running at 57% of GDP, cuts are unavoidable.
These political tensions are the main factor behind the 2.5% drop in the value of the euro against the dollar over the past few weeks.
Amid mounting strain, China’s tighter curbs on exports of rare earths angered the Trump administration. The US president riposted with additional 100% tariffs on all Chinese imports from 1 November, together with other restrictive measures, targeting software exports in particular. Trump threatened to cancel the meeting with President Xi, scheduled over two days on 31 October and 1 November in South Korea during the APEC (Asia-Pacific Economic Cooperation) summit.
In our view, China still holds some powerful cards. On the one hand, it has significantly scaled back exports to the US to only 10% of its total exports. The United States is highly dependent on Chinese rare earths, which are critical for the technology and defence sectors especially. With these levers available to Beijing, Washington will have to come to an agreement and avoid escalating frictions, which would be damaging for the US economy as a whole.
Equity markets have continued upward over the past few months. The world index gained 7.7% in euro terms since the start of the second half, buoyed by steep rises in technology stocks and the craze for artificial intelligence companies. These developments have further accentuated concentration in the US market. The market capitalisation of the 10 leading companies now exceeds 40% of the index, which is a record level.
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