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18 Feb 2013
Forex Flash: The Coming Push: France - BBH
Marc Chandler, Global Head of Currency Strategy at Brown Brothers Harriman notes that many investors have understandably not focused on France yet.
With the scandal in Spain, and Italian election and support needed for the banking infrastructure of both nations, attention has been more immediately diverted elsewhere. However, he feels that what looks to have been a free ride for France may be coming to an end. Chandler notes that despite the German economy contracting twice as much as the French in Q4 last year, the implications are much greater for France. He writes, “Recent data suggests that the German economy has stabilized and may be expanding albeit slowly this quarter. French data continues to disappoint.”
He feels that this is particularly important because the French government's growth forecast for this year is optimistic, well above the consensus and on the basis of the optimism that the Hollande government forecast that its deficit would fall to 3% of GDP, as the EU requires.
Chandler continues to add that following news that included the nineteenth consecutive monthly increase in French joblessness (Dec) and the larger than expected contraction in Q4, the French government will likely soon cut its 2013 GDP forecasts. He sees the issue as being whether it does so before of after the EC updates its forecasts at the end of next week. Currently the EC projects 0.4% growth in France, half of the government's forecast.
He notes that Hollande has sold the tax hikes and spending cuts on the basis that they were necessary to reached the 3% deficit target. Further, senior officials in the Hollande government, including Finance Minister Moscovici, are admitting, just six weeks into the new year, that the 3% target will be overshot. The push back was nearly immediate, with Asumussen, the German member of the ECB's board, was crystal clear: France and Germany have a special responsibility to meet the 3% target.
Additionally, and troublingly, Chandler adds that news that some EU members could be granted more time to bring their deficits in line with EU targets. However, without a programme in place to correct public finances, France may find that it is outside the realms of conditionality and it will have to continue with the original timeline. He writes, “ Hollande is under pressure to take additional remedial action. One area that he is being forced by circumstances to address is the pension system which runs a large deficit. Some reports suggest Hollande is preparing proposals that include decoupling pensions from inflation. Pension reforms undermined Sarkozy's support and Hollande's support has waned.”
In terms of policy, Chandler comments that outside of the hike of the marginal tax rate of high income earners and the modification of the higher pension age introduced by Sarkozy, Hollande´s policies as a Socialist do not seem that different. He adds that the modest liberalization of the labor market seems perfectly consistent with the neo-liberal agenda. He notes, “Perhaps Hollande has up until now relied more on tax increases than the right would have done, but that path appears to have been nearly exhausted and spending cuts loom.”
Looking at the market impact, he notes that investors still appear to regard French bonds as slightly better yielding German bund. He writes, “Over the past 60-days, the yield of the 2-year notes (of France and Germany) move in the same direct 96% of the time. The 10-year yields move together 93% of the time. French yields are inversely correlated to Italian yields, especially in the 2-year area, where the correlation is -63% (vs -11% in the 10 year sector). French bond yields are also inversely correlated with Spanish bonds at -43%. However, the correlation of 10-year bonds is zero, but trending up from -35% in mid-December.”
He finishes by commenting that investors who share misgivings about France should continue to monitor these correlations. He sees that a breakdown in the French-German correlation and an increase in the French-periphery correlation would suggest a new phase of Euro area tension is at hand.
With the scandal in Spain, and Italian election and support needed for the banking infrastructure of both nations, attention has been more immediately diverted elsewhere. However, he feels that what looks to have been a free ride for France may be coming to an end. Chandler notes that despite the German economy contracting twice as much as the French in Q4 last year, the implications are much greater for France. He writes, “Recent data suggests that the German economy has stabilized and may be expanding albeit slowly this quarter. French data continues to disappoint.”
He feels that this is particularly important because the French government's growth forecast for this year is optimistic, well above the consensus and on the basis of the optimism that the Hollande government forecast that its deficit would fall to 3% of GDP, as the EU requires.
Chandler continues to add that following news that included the nineteenth consecutive monthly increase in French joblessness (Dec) and the larger than expected contraction in Q4, the French government will likely soon cut its 2013 GDP forecasts. He sees the issue as being whether it does so before of after the EC updates its forecasts at the end of next week. Currently the EC projects 0.4% growth in France, half of the government's forecast.
He notes that Hollande has sold the tax hikes and spending cuts on the basis that they were necessary to reached the 3% deficit target. Further, senior officials in the Hollande government, including Finance Minister Moscovici, are admitting, just six weeks into the new year, that the 3% target will be overshot. The push back was nearly immediate, with Asumussen, the German member of the ECB's board, was crystal clear: France and Germany have a special responsibility to meet the 3% target.
Additionally, and troublingly, Chandler adds that news that some EU members could be granted more time to bring their deficits in line with EU targets. However, without a programme in place to correct public finances, France may find that it is outside the realms of conditionality and it will have to continue with the original timeline. He writes, “ Hollande is under pressure to take additional remedial action. One area that he is being forced by circumstances to address is the pension system which runs a large deficit. Some reports suggest Hollande is preparing proposals that include decoupling pensions from inflation. Pension reforms undermined Sarkozy's support and Hollande's support has waned.”
In terms of policy, Chandler comments that outside of the hike of the marginal tax rate of high income earners and the modification of the higher pension age introduced by Sarkozy, Hollande´s policies as a Socialist do not seem that different. He adds that the modest liberalization of the labor market seems perfectly consistent with the neo-liberal agenda. He notes, “Perhaps Hollande has up until now relied more on tax increases than the right would have done, but that path appears to have been nearly exhausted and spending cuts loom.”
Looking at the market impact, he notes that investors still appear to regard French bonds as slightly better yielding German bund. He writes, “Over the past 60-days, the yield of the 2-year notes (of France and Germany) move in the same direct 96% of the time. The 10-year yields move together 93% of the time. French yields are inversely correlated to Italian yields, especially in the 2-year area, where the correlation is -63% (vs -11% in the 10 year sector). French bond yields are also inversely correlated with Spanish bonds at -43%. However, the correlation of 10-year bonds is zero, but trending up from -35% in mid-December.”
He finishes by commenting that investors who share misgivings about France should continue to monitor these correlations. He sees that a breakdown in the French-German correlation and an increase in the French-periphery correlation would suggest a new phase of Euro area tension is at hand.