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French Market Stress Enters Second Day as Political Fears Mount

(Bloomberg) -- French assets came under pressure for a second day as Prime Minister Francois Bayrou’s decision to call a confidence vote continued to ripple through markets.

France’s CAC 40 fell 1.9%, extending losses from Monday. The yield difference between French and German 10-year debt — a key measure of risk — widened by three basis points to 78 basis points, up from 70 at the end of last week. The spread is heading for its highest close since April.

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“This is a blatant comeback of the risk premium on French assets which had always been in the background,” said Andrea Tueni, head of sales trading at Saxo Banque France. The market is “acknowledging the fact that France is in a deep political crisis amid a difficult economic backdrop.”

French financial stocks were among the biggest decliners, with AXA SA, Societe Generale SA and BNP Paribas SA all down 6% or more. A Barclays plc basket containing companies most exposed to French domestic risks, including the budget, was down 3.7%.

Bayrou said Monday that French President Emmanuel Macron had agreed to call parliament back into session early in order to allow the government to present its fiscal plan and to hold the confidence motion.

The far-right National Rally party, the leftist France Unbowed and the Greens all said they would vote against the Sept. 8 motion while the Socialists said they wouldn’t back the government. If a majority of lawmakers vote against Bayrou, he’ll be forced to submit his government’s resignation — the same fate that befell Michel Barnier’s administration last year.

“I think there has been a lot of complacency across markets about the budget situation in France,” said Vincent Juvyns, chief investment strategist at ING in Brussels. “It’s a two-tier Europe we have now with some countries like Germany who can afford to spend on growth and those who have no choice but to consolidate their public finance.”

The euro rose 0.1% to $1.1631, paring earlier gains. One-week volatility headed for its biggest jump in a month, with the political risk in France adding to the move.

What Bloomberg Strategists Say...

“Political instability is eroding French bonds’ traditional core status. With austerity plans dividing parliament, France’s borrowing costs risk climbing further, leaving both bonds and equities struggling to regain momentum.”

—Nour Al Ali, Macro Markets & Squawk, London. Click here for the full analysis.

Concerns over the nation’s fiscal situation have increasingly weighed on French assets in the past year.

French stocks have been battered since Macron called a snap parliamentary vote early June last year, taking markets by surprise. The CAC 40 has dropped over 4% since then, while the Stoxx Europe 600 rose about 6%. The CAC is set to underperform the pan-European benchmark for a second year, a sharp turnaround for the French index which outperformed every year but one since Macron was elected in 2017.

Oddo BHF strategist Thomas Zlowodzki said Bayrou’s gamble is risky and there’s a high chance of the government failing. His team is underweight on French stocks on the grounds that their valuations do not fully price this risk.

Meanwhile, the nation’s 10-year yields are now among the highest-yielding in the eurozone, having already surpassed countries once at the heart of the European sovereign debt crisis such as Greece and Portugal. The moves this week have left the yield just seven basis points below Italy’s.

“The big next step would be the yield on French 10-year bonds topping those of Italy,” said Saxo’s Tunei. “That would really be a significant milestone.”

--With assistance from Greg Ritchie, William Horobin, Vassilis Karamanis and Allegra Catelli.