(Bloomberg) -- French bonds and stocks came under renewed selling pressure after Marine Le Pen’s party said they would support a no-confidence vote in Prime Minister Michel Barnier’s government.
The spread between 10-year French and German notes climbed eight basis points — the biggest widening move since June — to end the day at 89 basis points, close to the highest level since 2012. The CAC 40 index dropped as much as 1.2% before erasing those losses, while the euro fell more than 1%.
Barnier used a constitutional tool to ratify parts of his unpopular budget bill without a parliamentary vote, after days of negotiation. While he offered a final-hour compromise to Le Pen by committing to not cut reimbursements for medicines, that wasn’t enough to win the National Rally’s support.
“The base case now is for Barnier’s government to fall,” said Benoit Gerard, a rates strategist at Natixis SA, adding that the new equilibrium level for the spread is around 100 basis points. “Lack of governability is now clearer than before.”
The political wrangling threatens to derail the government’s efforts to reduce a ballooning deficit that is forecast to widen to 6.1% of gross domestic product this year. The impasse has weighed heavily on French securities, which have underperformed euro-area peers ever since President Emmanuel Macron shocked markets by calling a snap election in June.
“France is just a structurally deteriorating credit, and the politics are creating immediate stress and speeding up the process of adjustment,” said Neil Mehta, a portfolio manager at RBC BlueBay Asset Management. “We see spreads capped at 100bps for now, however, political sea change may not come until the next presidential election in 2027, so difficult to get optimistic.”
The extra yield investors demand to hold 10-year French bonds compared to safer German paper is near the highest its been since the euro-area debt crisis over a decade ago. At one point last week, the rate on benchmark bonds surpassed those on equivalent Greek debt. The next milestone would be closing the gap to Italy, the region’s traditional poster-child of fiscal profligacy.
Bigger Issues
“Whether the government falls or not, France’s issues are bigger than that,” said Robert Dishner, senior portfolio manager at Neuberger Berman in an interview on Bloomberg TV. “The direction of travel does feel like we will be moving wider on French spreads.”
Meanwhile, signs are growing that the political crisis is weighing on the outlook for the euro. The common currency tumbled as much as 1.1% to $1.0461 while one-week risk reversals, a gauge of trader sentiment in the options market, flipped bearish after briefly favoring the currency last week.
The most domestically exposed shares such as banks, real estate and food retailers were the biggest drag on the nation’s stock index. The CAC small and midcaps benchmark fell 1.8% and closed at its lowest level in over a year.
Barnier’s original plan, which was welcomed by investors, saw €60 billion ($63 billion) of spending cuts and tax hikes to bring the deficit to 5% of GDP next year. But Marine Le Pen’s party is demanding tweaks to Barnier’s budget, including to his plans to raise taxes on electricity, as well as measures to curb pensions expenditure and reduce state reimbursement of medicines.
While some concessions could avoid the government being toppled in the short term, they’d dilute the fiscal tightening investors say is crucial to put the deficit on a sustainable path. Mauro Valle, head of fixed income at Generali Asset Management, said if the government gives in to Le Pen’s demands, the budget bill will project a deficit exceeding 5%.
“In either case, the spread is likely to remain in the range observed in recent days for the next few weeks, pending political developments,” said Valle. There’s “a non-negligible risk of the market testing the 100bps level from January onwards, when funding activity resumes,” he added.
--With assistance from Vassilis Karamanis, James Hirai, Alice Atkins, Greg Ritchie, Naomi Tajitsu and Michael Msika.
(Updates prices.)
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