France Is Causing Issues

I’ve written about bond stress a fair amount over the last month or two, but I feel like I’ve somewhat glossed over foreign troubles. Right now, the main global bond stress is in France, and I think it’s fair to say it’s helping push around assets, a bit. What’s the problem and how can it be solved?

The basic issues are fairly common and have been around quite a while. They have a lot of debt and large deficits. Why does that suddenly matter so much? Now they also have political gridlock and an energy shock to deal with. That’s causing more bond stress in an already stressed system and driving the spread between their OATs (yields shown below) and German Bunds to levels not seen since the 2012 eurozone crisis.

Briefly, deficit spending has driven their debt to 119% of GDP, up from 98% in 2019. With the deficit at about 5.4% of GDP for 2026, this number is likely to only get worse. That deficit is worse than the earlier target, which is also causing political stress. Interest costs are rising rapidly and are working towards becoming the biggest budget item.

Meanwhile, economic growth is weak and in a downtrend. It’s easy to imagine a 2027 recession if this path continues, though that’s not a given. Lower energy prices would likely help shift the trend. Cutting spending has been proposed, but lowering social spending is deeply unpopular amongst a fair amount of the population. That’s adding to political instability.

What’s a way out? Honestly, that seems like a very tough question, to me. Cutting spending seems necessary, and the hope is that a compromise can be reached. Long term, France needs to produce enough to support the economy, and I don’t see much of a push in that direction. Short term, France needs to regain investor confidence that they are a reasonable credit.

As Jens Nordvig, author of The Fall of the Euro, says, short-term, an answer probably is a question of if the political will is there to keep investor confidence. Politics everywhere has become more balkanized, but I’d sure like to think an acceptable budget will come out to soothe investor concerns. Many plans should be more acceptable than the current uncertainty.

Longer term, it’s hard to see how there isn’t an eventual crisis, though when it hits is hard to know. From an American perspective, the euro is heavily weighted in dollar value calculations, and France is the second-biggest euro country, so this has helped strengthen the dollar. Presumably, a resolution to these problems could help the dollar fall, which would likely support US assets. Any resolution seems unlikely to last, though, as the French economy continues to suffer.

While a troubled France isn’t helpful to the US, I don’t regard it as a big driver, either. It affects FX, which has hurt stocks a bit, but the AI trade, which I talked about yesterday, is a bigger deal. I’m much more focused on AI spend and prospects than I am on France. However, France is helping add to bond stress, and a lessening of that worry can help our yields and support risk assets.

Fed head Hammack said more policy tightening is needed, which helped hit risk assets on a slow news day.

Japan’s PPI was 6.8% Y/Y vs. prev. 7.6%, easing pressure to hike again.

Korea’s Kospi index was -5% overnight, off the lows of -7%, on what appears to be foreign and institutional selling. Their President also said they may have to raise interest rates.

In general, semiconductors are also selling off on concerns of Chinese competition, as ChangXin Memory has made great progress on the new memory architecture.

Earnings season kicks off this morning, with United Health (UNH) beating estimates and modestly raising guidance, sending shares up 3%.

ADP Employment, Existing Home Sales, and the Federal Budget Balance, today.

Bottom Line: Semiconductors continue to be stressed, in part from fears of Chinese competition.

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