No panic about French rates, despite political instability

As expected, François Bayrou lost the confidence vote on Monday, leading to the fall of his government. This time, Emmanuel Macron was quick to react, appointing Sébastien Lecornu to replace him straightaway. Fundamentally, the problem remains the same: passing a budget that reduces the deficit in a parliament that is divided into three blocs. This political deadlock is causing spreads to widen at a time when rating agencies are preparing to reassess France's credit rating.

After Spain, Portugal, and Greece, France should soon be borrowing at higher rates than Italy. Indeed, the spread between Italian 10-year bonds and French 10-year bonds has narrowed to a few basis points, illustrating the reversal of dynamics between these two countries.

For years, one of France's strengths for international investors and rating agencies was its political stability, while Italy saw a succession of governments. Giorgia Meloni has been in power for three years now, while Sébastien Lecornu is the fifth French Prime Minister in just three years.

However, the spread relative to Germany remains contained. While the 80bp level has once again been exceeded, the recent peak is below the 83bp seen when the National Assembly was dissolved and the 88bp following Michel Barnier's fall last December. The markets seem to have become accustomed to this French-style political instability.

Beyond the spreads, French rates have not gone off the rails either, despite the political deadlock and a deficit of over 5%.

Nevertheless, rates have been trending upward in recent months, further complicating the budget equation. The debt burden (interest payments) has doubled in five years, reaching €55bn this year.

Towards a further downgrade?

Investors are now watching Fitch Ratings, which is set to update France's rating after the markets close on Friday.

Fitch, often considered a frontrunner amongst the agencies, will review its AA- rating with a negative outlook. Moody's and S&P Global, which assign equivalent ratings, will follow suit in October and November.

A downgrade by Fitch would bring France's rating to A+, seven notches above speculative grade and the lowest level amongst its peers.

France's rating was already downgraded by Moody's after the fall of the Barnier government last year.

However, the impact of rating downgrades by agencies must be qualified. Market reactions are often fairly neutral when such an announcement is made.

Why? Because rating agencies are somewhat of a lagging indicator and the market has already "done the work" when a downgrade occurs.

This is the observation we made above. France already borrows at higher rates than Spain, Portugal, and Greece, countries whose ratings are several notches lower than France's. In other words, the market no longer treats France as an AA country.