The Strategist

Developments in the French debt situation: loss of safe haven status?

French bonds are once again in the spotlight and, for the first time since 2007, are perceived by the market as riskier than Spanish government bonds - despite Spain having a credit rating three notches lower. Simultaneously, the interest rate spread over German bonds has widened from around 50 basis points in June to 80 basis points. But how did this development occur? To better understand this, a look at the events of early summer 2024 is worthwhile.

Date
Author
Simon Weiss, Head Fixed Income Strategy LGT Private Banking Europe
Reading time
10 minutes

The Strategist Frankreich Zinsen
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Political instability and its consequences

After a rightward shift in the European Parliament elections, French President Emmanuel Macron came under pressure: his alliance suffered significant losses, and in response, Macron unexpectedly dissolved the National Assembly and called for elections. This move, aimed at securing more support for the remaining three years of his term, proved to be a miscalculation. The resulting political uncertainty unsettled financial markets and once again drew attention to France's national debt.

Additional pressure came from the rating agency Standard & Poor’s, which downgraded the credit rating of French government bonds to "AA-". The reason for this was the expected increase in the budget deficit in the coming years. This downgrade caused the interest rate differential between French and German government bonds to rise to a level not seen since the euro crisis of 2010.

Summer calm and renewed difficulties

During the comparatively quiet summer months, political tensions in France temporarily receded. The Summer Olympics in Paris also contributed to a sense of relaxation. However, with the appointment of the new government under Prime Minister Michel Barnier last month, political and economic issues have returned to the forefront.

The elections did not result in clear majorities, and the new government consists of a coalition of Macronists, their allies, and members of the conservative party Les Républicains. Although the government has shifted politically to the right, it lacks a majority in parliament. To pass legislation, it relies on shifting alliances - either with the left-wing coalition or the right-wing populists. This fragile situation carries the risk that the government could be toppled at any time by a joint vote of no confidence. At the same time, the French economy has shown clear signs of stagnation since the beginning of the year, particularly in the manufacturing sector. This will lead to a decline in tax revenues and is expected to result in a higher budget deficit than previously forecasted.

Future challenges and outlook

France thus faces the difficult task of managing its debt problem and growing deficit in an environment of political instability and weaker economic performance. Failure could not only result in sanctions from the EU, which insists on compliance with the Maastricht criteria, but also in further downgrades by rating agencies. In this case, rising risk premiums over German bonds and thus higher financing costs would be inevitable.

However, there is hope in the long term: the French economy is broadly diversified, and leading companies in various sectors have the potential to recover from setbacks. To ensure this potential is not wasted, decisive structural reforms and political stability are necessary. Otherwise, it is not out of the question that France could lose its status as a "safe haven" and long-term slide into the financial periphery of the eurozone - with correspondingly negative impacts on the risk premiums of French government bonds.

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