(Bloomberg) -- Investors are spurning French assets as they lose confidence in the ability of a new government to survive the coming months.
The risks have sent the nation’s bond yields to the highest relative to lower-rated Spain since the global financial crisis, while stocks in Paris are the only major European market set for losses in 2024. The likes of Citigroup Inc., Barclays Plc and Royal London Asset Management warn a new cabinet could quickly stumble, leaving France without an administration again.
The moves signal there’s no end in sight to turmoil in French markets since an election result in July produced political gridlock. The new ministers have little time to cobble together a budget aimed at tackling France’s deficit before facing a showdown with a hostile parliament next month.
“Markets are waiting to see if the new government can hold,” said Francois Rimeu, a strategist at La Francaise Asset Management in Paris. “There’s a risk that it falls,” he said, adding one couldn’t rule out a “second leg” to the crisis.
A gauge of French bond risk — the gap between French and German 10-year yields — is at the highest since anxiety over the country’s politics was at its peak this summer. Citigroup expects it to widen to as much as 100 basis points next year, up from around 80 now. Meanwhile, French stocks have slid over 6% from when President Emmanuel Macron called snap elections on June 9.
Data on money flows is not encouraging. Earlier in September, France equity funds chalked up their biggest outflow since December, according to EPFR. And Japanese investors sold French sovereign bonds en masse in July, a sign that one of Europe’s safest assets has been tarnished in the eyes of some of its biggest holders.
“I don’t see much appetite from investors to go back to French assets,” said Emmanuel Cau, head of European equity strategy at Barclays. “Investors want to see whether a budget can be passed,” he said, adding the market was “weary” about the prospect of another election next year.
‘No Future’
The first challenge for Prime Minister Michel Barnier’s new government will be delivering the already-delayed budget. An Oct. 1 deadline to present it to parliament for debate is likely to be the first opportunity for a party to call for a no-confidence vote.
The left-wing New Popular Front alliance — which holds the largest number of seats in the lower house — has pledged to topple the government at the earliest opportunity. Meanwhile, Marine Le Pen’s National Rally party has indicated the new government has “no future.” Even if Barnier, best known for negotiating for the European Union in Brexit talks, can get a budget bill past lawmakers, he will then have to answer to the bloc’s rules.
The EU has already reprimanded the previous government for running an overly large deficit. France’s debt level relative to the size of its economy is well above that of Spain and Portugal, traditionally considered more risky for bond investors.
“I think the headwinds for France are pretty large,” said Gareth Hill, a portfolio manager at Royal London Asset Management, who has maintained an underweight position on French debt since before the elections. “Barnier is now in place so at least there is a prime minister to do things like submit budgets, in theory at least,” he said, adding things still “feel very fragile at this stage.”
The political situation and markets have seen little improvement in the month since a small band of investors, including Jupiter Asset Management and hedge fund Mount Lucas Management, said they were starting to snap up French bonds based on the view that the selloff was overdone.
Ratings Gauntlet
The latest economic data is also worrying. The euro area’s private-sector economy shrank for the first time since March, with the end of France’s Olympic boost and a deepening manufacturing downturn heightening concerns that the region’s recovery has run out of steam.
That’s a problem for the French stock index since its heavyweight constituents in the luxury sector means it is tilted toward companies tied to economic momentum. In recent weeks, the value of stocks listed in Paris has fallen below that of Toronto for the first time since 2022.
Finally, within weeks of the budget discussions, ratings companies will also give their verdict on the country’s finances. Fitch Ratings will review France on Oct. 11, following by Moody’s Ratings on Oct. 25. The latter has warned the outlook may be lowered to negative from stable if fiscal and debt outcomes worsen. S&P Global Ratings has already downgraded the country this year.
The rating risks are “potentially greater this time around,” said Aman Bansal, a rates strategist at Citigroup. The nomination of a prime minister and new cabinet “does not really alleviate risks to the government’s longevity, policy paralysis, needed fiscal consolidation, or the credit rating.”
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