By François Rimeu, Senior Strategist, Crédit Mutuel Asset Management, Noovember 27, 2024
At the time of writing, the draft budget for 2025 is being considered by the Senate, which could reverse spending cuts initially outlined in the text. The European Commission, for its part, has given its support to the government, welcoming its austerity efforts, while Marine Le Pen threatens to bring down the government by backing a censure motion with the Left Party if certain measures are not withdrawn (increase in electricity taxes in particular).
France is currently facing a political crisis as rarely experienced under the 5th republic and an equally worrying economic situation. The latest Purchasing Managers’ Indices for France show a situation that is deteriorating further with little chance of seeing this negative trend reverse in the short term.
Since the announcement of the dissolution of the National Assembly last June, French assets have significantly underperformed their European counterparts :
- From 10 June to 26 November, the CAC 40 was down -8.3% while the Stoxx 600 was down only -2.3%.
- Over the same period, French debt has also been under pressure:
- The spread between the OAT (10-year French sovereign debt) and the bund (German 10-year government bond yield) widened from 0.47% to 0.82%;
- The spread between the Spanish 10-year government bond yield and the OAT tightened from 0.25% to -0.10%;
- The spread between the Italian 10-year government bond yield and the OAT tightened from 0.84% to 0.44%.
So the questions we face today are: What are the possible scenarios and what are the potential impacts ?
We see two possible scenarios with multiple ramifications :
- Either the efforts made on the budget are not enough to the RN's liking and the censure motion passes,
- Or the Barnier government passes a more or less amended budget via Article 49.3 of the Constitution and survives a potential censure motion (with no doubt a National Assembly (RN) that would abstain from voting).
Before we consider these scenarios and the potential ramifications, it is useful to recall some data for France:
- Debt to GDP ratio: 112.7%
- Estimated 2024 budget deficit: -6.2%
- Estimated 2024 primary deficit: -4% (the worst in the euro area along with Slovakia; by way of comparison, Italy stands at -0.4%)
- Projected 2025 Budget Growth (derived from draft budget bill): +1.1%
Scenario 1:
Currently, we believe that there is a 50% probability that the Barnier government could fall. Investment banks seem a little more optimistic with an average probability of around 30%. In this scenario, it seems likely that the OAT vs 10-year Bund spread would initially rise to 95-100 basis points (bps) and that French equities would underperform other European indices by 2 to 3%.
The logical next step would be to activate article 47 of the Constitution with a newly appointed government implementing its policy (and therefore the budget) without a vote. It should be noted that this would only be possible if parliament fails to come to a decision. However, a parliament that rejects a text is in fact a parliament that has taken a decision, which would make this provision inapplicable. The next step is a debate among constitutionalists, which we are not, and which would open the door to very unstable times ahead (for more details: « On est vraiment dans l’inconnu » : le scénario d’une Assemblée incapable de voter le budget agite les constitutionnalistes - Public Sénat (publicsenat.fr)).
Uncertain times could lie ahead; probably negative for the growth outlook, with little chance of stabilization before July elections. In this context, rating agencies would logically be harsh with France and would most likely downgrade its rating.
Scenario 2:
In the 2ndh scenario, where the Barnier government would survive a motion of censure, there would inevitably be a general sense of relief and therefore a rebound in French assets. A return to around 70 bps on the spread of the OAT vs the 10-year Bund seems possible, as well as a slight outperformance of French equities, somewhere around of 1-2%. However, this relief is likely to be relatively short lived:
- First of all, because the survival of the Barnier government would be linked to cancellations of spending cuts, which would automatically raise 2025 budget deficit estimates (currently at -5% at best);
- Secondly, because these deficit calculations are based on a 1.1% growth rate assumption for 2025 which in our opinion is optimistic. Unfortunately, growth of around 0.6-0.7% seems more realistic in our opinion.
- And finally, because upcoming elections in July of 2025 will likely weigh on investors and their intention to increase investments in French assets.
Even if rating agencies were to give France time, it would probably only postpone the loss of the AA rating to later, when deficit targets are not met because of overly optimistic growth targets.
As you can see, we remain very cautious on French assets today. The challenges facing the French economy are dizzying: an ageing population, debt, a lack of productivity, and so on, not to mention the fact that these problems are present in most European economies and that the geopolitical situation is unstable to say the least.
Source of data: Bloomberg
This commentary is for information purposes only. The opinions expressed by the author are based on current market conditions and are subject to change without notice. These views may differ from those of other investment professionals. Issued by La Française Finance Services, registered office at 128 boulevard Raspail, 75006 Paris, France, which is regulated by the Autorité de Contrôle Prudentiel as an investment services provider, no. 18673 X, subsidiary of La Française. Crédit Mutuel Asset Management: 4, rue Gaillon 75002 Paris is a management company approved by the Autorité des marchés financiers under number GP 97,138. Société Anonyme with capital of €3871680, RCS Paris n° 388,555,021, Crédit Mutuel Asset Management is a subsidiary of Groupe La Française, asset management holding company of Crédit Mutuel Alliance Fédérale.