Mark Twain’s aphorism that “history doesn’t repeat itself, but it often rhymes” may be overused. But the market reaction to the political turmoil gripping France has distinct echoes of the euro crisis more than a decade ago. As talk of ‘Frexit’ surfaces, it’s important to note that there are significant differences between the current situation and the travails suffered by the ‘PIGS’—Portugal, Italy, Greece and Spain—back in the day.
Mark Twain’s aphorism that “history doesn’t repeat itself, but it often rhymes” may be overused. But the market reaction to the political turmoil gripping France has distinct echoes of the euro crisis more than a decade ago. As talk of ‘Frexit’ surfaces, it’s important to note that there are significant differences between the current situation and the travails suffered by the ‘PIGS’—Portugal, Italy, Greece and Spain—back in the day.
France is part of the bedrock of the European Union (EU), not just a peripheral nation. Its economy is nowhere near as weak as Greece’s was in 2012. While both its budget deficit and debt burden are deteriorating, neither is as bad as those of Italy. Moreover, the European Central Bank is now much more proficient at coming up with new tools to defend the common currency project.
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France is part of the bedrock of the European Union (EU), not just a peripheral nation. Its economy is nowhere near as weak as Greece’s was in 2012. While both its budget deficit and debt burden are deteriorating, neither is as bad as those of Italy. Moreover, the European Central Bank is now much more proficient at coming up with new tools to defend the common currency project.
The EU’s collective ability to set aside differences, displayed during the euro crisis and repeated in its €800 billion ($850 billion) NextGeneration pandemic fiscal programme, is its greatest strength. Its willingness to compromise on even the thorniest of political and economic issues means the risk of a ‘Frexit’ can be firmly discounted at this juncture.
That said, fixing France’s finances also looks unlikely. The political jockeying following President Emmanuel Macron’s decision to call a snap election has highlighted the country’s intractable debt problem; French bond spreads won’t magically return to the previous narrow levels compared with benchmark German yields even after the political picture becomes clearer by the second-round results on 7 July.
A change in the rating outlook or a downgrade from Moody’s Investors Service, which ranks French government debt at Aa2 with a stable outlook, is probably already priced in. But further action from either Fitch Ratings or S&P Global Ratings, which have the nation one notch lower at AA-, would be unsettling.
In recent trading days, French 10-year yields have barely budged, while German bonds have tracked a sharp decline in US Treasury yields. The French Treasury has completed more than half of its €310 billion gross funding requirement this year, with sales going smoothly.
Yields across the curve are in the 3% to 3.5% range, only modestly above this year’s average levels. In 2012, the French yield premium to Germany reached 128 basis points. This current wobble, which has seen the spread surpass 80 basis points, is more reminiscent of the market move in the approach to Macron first taking office in 2017.
So-called cohabitation between opposing parties holding the offices of president and prime minister has happened three times before in the 66-year history of the Fifth Republic. If Marine Le Pen’s National Rally gets to lead the next government, it’s worth noting that her party has carefully moderated its eurosceptic stance in recent years, pushing instead for reform from within.
Nonetheless, European Commission concern about the increasing French budget deficit, which rose to 5.5% of GDP last year, won’t be assuaged by a tense domestic political scene.
During the euro debt crisis, it took then-ECB President Mario Draghi promising to do “whatever it takes” in July 2012 to steady the ship. Current incumbent Christine Lagarde doesn’t need to worry her speechwriters yet, but it would be wise to have internal consultations on which tools from its expanded arsenal the ECB might bring to bear if the current market moves threaten to become dysfunctional.
The ECB’s Transmission Protection Instrument (TPI), for example, was approved in July 2022. It helped to quell an Italian political wobble, but it remains more of a conceptual tool than a real-life bazooka, with an explicit aim to “counter unwarranted, disorderly market dynamics.” We are far from that definition; “What we’re seeing is a repricing,” ECB Chief Economist Philip Lane pointed out earlier this week. Still, policymakers in Europe might want to remind market participants that the TPI exists.
The central bank announced at its 6 June meeting that it will commence running down its Pandemic Emergency Purchasing Programme by €7.5 billion per month from July, by no longer fully reinvesting maturing holdings.
Pressing pause might be taken as a sign of panic; but there’s plenty of inbuilt flexibility that would allow redemptions from other markets to be skewed toward reinvestment in French debt—a chunky €18 billion matures in July, for example.
President Macron’s electoral gamble has focused investor attention on the parlous state of French finances and opened the door to a new administration that may be even less fiscally responsible. But still, we are a long, long way from the turbulent markets of 2012. ©bloomberg