Christopher Dembik
Head of Macroeconomic Research
Summary: It's Germany to the rescue as France's banking system stands on the brink of collapse.
France is one of the European countries facing the highest wall of debt in the coming years. Before the Covid-19 pandemic outbreak, public debt was flirting with the 100% of GDP threshold and private debt was skyrocketing, reaching nearly 140% of GDP – far more than that of Italy (106%) or Spain (119%). And the emergency pandemic response has only accelerated the piling on of debt, with the level of public debt expected to rise above 120% of GDP in 2021. Private debt, mostly corporate, could increase another 20% in the worst-case scenario, growing faster than anywhere else in Europe.
At the same time, French companies on average have one of riskier credit profiles in the European space, with rapidly widening credit spreads. Despite a massive stimulus package of €100bn and a loan scheme in which the state has guaranteed up to 90% of the loans for companies, France is unable to avoid a wave of bankruptcies as many companies in the services sector are unable to cope with the series of “stop and go” lockdowns. Massive losses on state-guaranteed loans further weaken French banks which have been hit hard in previous years by weak growth and the low interest rate environment and, in some cases, by a slump in profits from their equity business. Investors are getting increasingly gloomy about the future return on equity, which triggers massive selling of French megabanks. Net revenue drops and loan provisions are on the rise, sending French banks’ market capitalisation and price-to-tangible book ratio to unprecedented low levels. Given the poor state of public finances and the already extraordinarily high level of debt, France has no other choice but to come begging cap in hand to Germany, in order to allow the ECB to print enough euros to enable a massive bailout of its banking system, to prevent a systemic collapse.
Trade: probably safer to buy the French banks after the bailout than selling them before, but both might be possible.
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As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
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