With eight months to go before the French presidential election, the country's assets are already showing signs of stress. France's borrowing premium relative to Germany (one of the most closely watched indicators of bond risk) is currently near its highest level since the 2012 European sovereign debt crisis.
For investors, the key question is how the successor to the pro-business centrist Macron will address deep-seated economic challenges, including a fiscal deficit exceeding 5%, soaring debt costs, and weak growth nearing recession.
Far-right candidate Marine Le Pen and far-left hopeful Jean-Luc Mélenchon have pledged to steer France in drastically different directions. Their proposals (which included participation in the first presidential debate last week) include increased spending to stimulate the economy, lowering the retirement age, cancelling some government debt, and even cutting off funding to the EU.
Louis-Vincent Gaff, CEO of Gavekal Research, commented on the French bond market, stating that with a lack of parliamentary majority, no budgetary space, and no political capital, it's unclear what Macron can do to stop the bleeding; on the contrary, the risk is that the bleeding could accelerate. Addressing France's mountain of debt has dominated recent debates. Despite the current government's attempts to reduce the deficit, its ambitions have been repeatedly undermined by a politically divided parliament. For long-term investors, the implied yield on 15-year French government bonds is a way to filter out the effects of short-term monetary policy and observe borrowing costs. The spread between this French benchmark and German rates of the same maturity is currently near its highest level since 2012, indicating that investors are pricing in a structural deterioration in France's fiscal health relative to Germany over the coming decades.
