German blue chips are more promising than French blue chips, Barclays strategists wrote in a note on Friday, saying France’s “longer-term fiscal and growth fundamentals” are weak and the risk of looming bond vigilantes is imminent.
The two largest economies in the euro zone are in trouble. Germany is grappling with an ongoing manufacturing slump that has made it a growth laggard in the European Union, while disputes over its budget and long-term fiscal strategy led to the collapse of its government earlier this month.
However, France’s borrowing costs have surpassed those of Germany this year as the country’s political instability unsettles markets.
France has been concerned about potential political uncertainty for years, given its deeply divided parliament, with no party or faction holding a majority. Investors are also concerned about the company’s ability to reduce its massive debt and avoid a credit rating downgrade.
A key question is whether French Prime Minister Michel Barnier’s fragile government can pass the budget proposed in October – which includes deep public spending cuts and 60 billion euros ($65.6 billion) in tax increases. — or whether it will be overturned in a vote of no confidence.
“French budget compromise remains possible,” Barclays strategists said on Friday. “But any relief is likely to be short-lived. There are no easy solutions to the political deadlock, and long-term fiscal and growth fundamentals remain poor,” adding, They maintain their preference for Frankfurt German DAX Index paris stock index CAC 40.
France’s left-wing New Popular Front coalition said it would propose a vote of no confidence if Barnier tried to force the budget through, so the government might need to concede to the far-right National Rally party to pass the motion.
Doing so, the Barclays strategist continued, is “arguably a relief given the high risk premiums embedded in French assets,” potentially pushing the spread between German and French government debt (the difference in yields between the two bonds) ) from about 84 basis points pushed up the current 70 to 75 basis point range of the past few months. They said this could boost the CAC stock market index by 2% to 3%.
However, they warned that if the government fell, the spread could widen to 100 basis points and send CAC down 4% to 5%, and “bond vigilantes could step in if a stable situation does not develop for the government” or if The government budget failed to pass.
The term “bond vigilantes” refers to bond market investors selling bonds to protest monetary or fiscal policies they don’t like, thereby increasing the government’s borrowing costs.
This comes after French borrowing costs were equal to those of Greece for the first time this week. The fact that investors are demanding the same interest on French bonds as on historically unstable Greek bonds – which has implemented sweeping market-friendly reforms since its sovereign debt crisis in the late 2000s – is seen as a major milestone.
Risk premiums in France have risen in the run-up to summer elections, with fears of an outright victory for the far right or left stoking jitters about populist fiscal policies that might not solve the debt problem.
CAC 40 Index Performance.
Beyond the short-term budget debate, Barclays found medium-term risk asymmetries to be “less favorable” for French markets and that “concerns about political instability and the longer-term fiscal trajectory are likely to persist”.
However, Barclays said any knock-on effects on the euro zone would be limited.
Jane Foley, senior currency strategist at Rabobank, isn’t convinced.
“A deterioration in French political and budget outcomes could trigger contagion across the euro zone. This would be reflected in higher bond yields and a weaker euro,” she said in a note on Thursday.
“This risk depends on budgetary and political stability elsewhere in the region. Germany’s debt and deficit position is better. That said, the country faces serious structural problems that may require more government investment. It is also possible that There is a snap election early next year, the result of which may determine whether the country’s debt brake is lifted.
“At the same time, the eurozone lacks strong leadership in both Germany and France,” Foley added.
—CNBC’s Holly Ellyatt contributed to this article.
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