France – Short lived fears or lasting change?
Last Tuesday, Bayrou called a confidence vote on his budget, a move that is likely to bring down his coalition. Elections should not be triggered, and a new PM is expected to piece together a budget through concessions across the spectrum. New presidential elections can be excluded for the moment, and the Rassemblement National is not in a position to take power.
Markets are refocusing on France’s fiscal outlook. The fiscal trajectory is deteriorating, with debt-to-GDP set to rise substantially in the coming years from the already high level of 115%. It will be very difficult for the government to reduce the budget deficit from an expected 5.4% of GDP this year to 4.6% next year. Bayrou’s target was always unrealistic, and the deficit now looks set to come in closer to 5.5–6% by 2026. Any absence of consolidation would almost certainly lead to rating downgrades, with rating agencies due to deliver reviews right after the confidence vote. Downgrades are already partially priced, with the OAT-BTP spread near zero, the OAT-ESTR at 100 basis points and the OAT-Bund at 80 basis points. We think the latter remains wide, but further volatility cannot be excluded ahead of 8th September.
Much will depend on the extent to which markets are prepared to absorb France’s fiscal slippage, though the risk of a blow-up still appears remote for now and the outcome is likely to be more of the same gradual deterioration we have seen so far.
FED – Independence at risk. Will law preserve it?
Last week, Trump dismissed Fed Governor Lisa Cook with a shocking letter. She has appealed, and the courts will now decide — an unprecedented situation in Fed history. Trump’s team is seeking greater influence over the Fed Board, which in turn plays a key role in shaping regional Fed nominations. We see risks tilted toward higher term premia and a weaker USD if Fed independence is perceived to be eroding.
Algebris Investments’ Global Credit Team
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