(Bloomberg) -- French bonds and stocks came under renewed pressure after Marine Le Pen’s far-right party renewed its threats to bring down Prime Minister Michel Barnier’s government if its demands over the 2025 budget aren’t met.
The spread between 10-year French and German notes widened three basis points to 83 basis points on Monday while French banking stocks slipped after National Rally on Monday said it will vote to topple the government as soon as this week unless there’s a “last minute miracle.”
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, with the risk premium on 10-year bonds trading near levels last seen during the euro-area sovereign debt crisis.
“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. “The hurdle is high for the government to comply with National Rally’s requests.”
Shares in BNP Paribas SA fell as much as 2.3%, Societe Generale SA as much as 3.2% and Credit Agricole SA as much as 2.5%. The CAC 40 slipped as much as 1.2%. The French benchmark is a rare developed-market underperformer in 2024, down 4.4% so far this year, a consequence of political turmoil.
“It’s complicated to be bull Europe today,” Kevin Thozet, a member of the investment committee at Carmignac in Paris. “I think that depending on what happens in the next 72 hours, it’s rather complicated to be positive on the CAC 40, on the euro, on French risk premiums.”
Signs are growing that the political crisis is weighing on the outlook for common currency. The euro tumbled as much as 0.8% to $1.0496 while one-week risk reversals, a gauge of trader sentiment in the options market, flipped bearish after briefly favoring the currency last week.
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.
National Rally President Jordan Bardella said on Monday he’s got “little hope” he’ll see Barnier change his plans.
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 in 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.
France’s bonds have been underperforming euro-area peers since President Emmanuel Macron shocked markets by calling a snap election in June. The nation’s yields have crossed those of lower-rated countries including Portugal, Spain and, more recently, Greece. The next milestone would be closing the gap to Italy, the region’s traditional poster-child of fiscal profligacy.
“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.”
--With assistance from Vassilis Karamanis, James Hirai and Alice Atkins.
(Updates with comments and context on equities)
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