France's unwelcome rise to prominence

Yvan Berthoux - 13 December 2018

Forward-looking indicators of French industrial activity have plunged in recent months, leaving president Macron ‘s 7 per cent unemployment target looking insurmountable by 2022.  France’s unreformed economy and effervescent politics have kindled a furious protest movement, whose appeasement threatens a budgetary lapse much larger than Italy’s next year. How long before French OATs suffer a similar market revolt to the one that lifted Italian BTPs 200 basis points higher in the summer?

Even though the political uncertainty in Italy concerning the budget balance is still elevated due to the economic slowdown, it seems that market participants have been more focused on France lately due to the ‘yellow vests’ protests that have been degenerating rapidly. The movement started after the announcement of higher fuel prices and eco taxes that were set to come into effect in January, but has broadened into a grass-roots demonstration with French citizens showing their disaffection towards the effect of globalization, the disparities between the ‘haves’ and the ‘haves not’ and the imbalances between the omnipotent corporations and the powerless consumers, who have seen their purchasing power constantly decreasing over the past decade.

It is now clear that any form of policies that would have hurt the low- and middle-class households could have been followed by similar actions from protesters, and therefore increases President Macron’s challenges for 2019 after a volatile year. We saw that Macron’s approval rating fell to 23 per cent last week, which is lower than his Socialist predecessor Francois Hollande at the same time of his mandate, who was then considered to be the least popular leader in modern French history.

France’s sovereign debt has consistently priced at a small yield premium to German bunds (averaging 45 basis points at the 10-year maturity. As shown in figure 1 (left frame), the two main exceptions were during the 2010-2012 sovereign debt crisis and the French elections in 2017, where the yield differential widened to 200bp and 80bp, respectively, but these were small beer in comparison to the turmoil that Italy and Spain experienced. This reverie has been rudely interrupted by a reassertion of fundamental economic vulnerabilities.

First, France has an elevated structural unemployment rate, estimated at roughly 9 per cent. Meanwhile, Macron’s 7-percent target by 2022 (the end of his mandate) seems unachievable. Figure 2 (left frame) shows that while the unemployment rate for the Euro area has fallen by 4 percentage points since the highs of the sovereign debt crisis, France’s jobless rate merely dropped by 1-percentage point.  Despite ‘high’ unemployment, significant recruitment difficulties have appeared in the past couple of years with more than 300 thousand unfilled job offers in 2017 according to Pole Emploi.

In addition, France’s employment rate for the senior age group, 55-64, is at 55.2 per cent (as of Q3 2018), which is far below that of Germany (71 per cent) and in the G7 countries (64.4 per cent) and very close to the rate of Spain and Italy (Figure 2, right frame). This implies more government spending (e.g. on benefits and healthcare) in these countries where the sustainability of the debt becomes more debatable every single year. With economic activity expected to ease further over the next 6 months (figure 1, right frame), amplified by the ‘Yellow Vests’ effect, it looks like 2019 is going to be a challenging year for French officials. The budget deficit is expected to soar to 3.5% next year, breaking the Stability and Growth Pact 3-per cent limit after ‘only’ two years of fiscal discipline (figure 3, left frame).

With global liquidity conditions weakeneing and the ECB stepping out of the market, European equities have been trying to find their lows since the October sell-off, with financials experiencing significant drawdowns despite their cheap valuations. We think that France’s predicament will remain centre-stage next year, challenging Macron’s ambitious reform agenda and generating unusually high market price volatility.

Figure 1

Data Source: Eikon Reuters, EP

Figure 2

Data Source: Eikon Reuters, OECD

Figure 3

Data Source: Eikon Reuters, Trading Economics, EP

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