News in Charts: From Behind the Maginot Line
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“What you need to understand … is that the crisis in Europe is over,” François Hollande, President of France, 8th of June 2013
Introduction
Markets appear to agree with M. Hollande – the crisis is over, the euro zone economy is out of recession, and equity prices are on the rise. French and Euro Area officialdom has, since the recession, been focused on protecting the Core countries from the bad debts accumulated by the Peripheral economies. And they feel their efforts have been triumphantly successful – so much so that Mr Barroso last week described their joint efforts as “fantastic”.
A pity then that the French government seems to disagree. It lowered its growth forecast for 2014 to 0.9% from 1.2%. At the same time its estimate for that year’s budget deficit has been increased to 3.6% vs. an initial estimate of 2.9%. For 2013 the budget deficit is now expected at 4.1% from 3.7% reported previously. The changes in our view reflect a lacklustre recovery and a realignment of over-optimistic government projections with those of the IMF/OECD.
The threat from rising yields and a flight to safety in global capital markets that result from Fed tapering is not a problem for Germany – which needs tighter monetary conditions, and is regarded as safe – and the Peripheral economies will be protected by the ECB if necessary. But while all their attention was focused on defence against the risk from the Periphery, the banking crisis may have already reached the banlieues of Paris.
We identify a key risk that is not currently priced into the market, in the French corporate and banking sectors. French NFCs are experiencing low and falling profitability, reflected in stock market earnings. Moreover, French banks are highly exposed to French NFCs, and are also relatively vulnerable to a potential flight to safety in international capital markets. There is a pronounced risk that Fed tapering could trigger a major non-performing loan (NPL) problem in the French banking sector. But higher yields will erode the already weak profits of the corporate sector. And the prospect of capital flight is a threat to French banks. The central importance of French banks in the Euro Area means that a problem for them could quickly become a problem for the entire Euro Area banking system.
France is vulnerable…
The balance of opinions of Primary Dealers in the New York Fed’s survey is convinced that tapering will begin in September. We agree with that assessment and look to a modest reduction in the Fed’s rate of asset purchases to begin then, even after Friday’s mediocre non-farm payrolls data. This tapering will add to pressure on the most fiscally challenged European economies as their sovereign yields could follow US yields higher. But France is not among them – at least, not yet. Our Sovereign Fragility Index still has France in Aaa territory, but only barely. Further evidence lies in the fact that the rating agencies have been more cautious and have all stripped France of her AAA rating.
…and needs looser policy rates which are not on the horizon
Given the economic conditions prevailing in the country today the last thing France wants is tighter monetary conditions, such as might result from Fed tapering. France and Germany are both core Euro Area economies, but their needs are very different. Our Taylor rule analysis suggests that the German economy would not just survive but might actually benefit from tighter money – perhaps much tighter. But the French economy needs a monetary loosening. Higher interest rates in these circumstances could be profoundly damaging for the French corporate sector which in turn could lead to a substantial rise in NPLs there.
Fed tapering means NPLs could become a problem for its banks…...MORE
