The Eurozone is under pressure. This is further confirmed by looking at the evolution of the spread (that is, the gap) between the French 10-year debt (OAT, in blue) and the German equivalent (Bund, in pink), the benchmark for European bonds.
The gap keeps widening. Why is this concerning? The spread reveals the European faults.
On paper, German and French bonds are the most highly rated in the Eurozone, the ones favored by investors – with a slight preference for Bunds, stemming from a country known for its strong economy and equally renowned fiscal discipline.
France, meanwhile, benefits from the remnants of its economy as well as its significant weight in the Eurozone and the EU.
However, French debt is not equivalent to German debt. Consider the persistent budget deficits or, for example, the latest figures of French growth: +1.1% in 2016, far less than the government’s expectations (1.4%).
Thus, France has one foot in “the countries of the South,” those poor grasshoppers of the Eurozone and the EU who do not know how to meet Brussels’ deficit targets and their public spending. The spread between the OAT and Bunds serves as a thermometer not only for the French situation but also for the Eurozone in general.
For now, the spread is increasing. And investors are shunning French debt, which explains why the rate gap between French and German debts has significantly widened. For what reasons?
French political risk identified a primary factor: the Le Pen risk. Ms. Le Pen’s campaign is very clearly anti-European, and the FN candidate has repeatedly mentioned the possibility of leaving the euro. She criticizes the euro, wanting to exit from it because it is a “major obstacle to reindustrialization.”
Foreign investors doubt the virtues of a currency change for reindustrialization.
Another attack could come from an increasingly strong dollar. Indeed, the strength of the greenback—and thus the weakness of the euro—may have benefited European exporting companies, but this advantage risks being offset by the protectionism advocated by Trump, and above all, the excessive weakness of the single currency further weakens the European bond market.
The scenario of the Eurozone’s breakup is gaining traction. The risk is the dissolution of European projects.
