France's risk premium over German Bunds has passed 150 basis points, yet Capital Economics and Mapfre AM see a low risk of cross-border contagion. They point to structural safeguards that should keep the fallout largely within French sovereign debt. An open confrontation between a future French government and EU authorities over deficit discipline is a tail risk.
The premium on French government debt over German Bunds has moved past 150 basis points as fiscal troubles mount. Even so, the risk of a systemic euro zone debt crisis remains low compared with the early 2010s, according to analyses from Capital Economics and Mapfre AM.
Capital Economics Chief Europe Economist Andrew Kenningham wrote that France appears headed toward an escalating fiscal crisis that will likely push bond spreads higher. However, he said structural safeguards should keep the fallout largely confined to Paris's sovereign debt market.
Three conditions for a full-blown crisis
Ismael García Puente, Deputy Director of Investment Strategy at Mapfre AM, said a full-blown financial crisis would need a French government denying its fiscal reality, European partners willing to let it collapse, and no institutional crisis tools. According to García Puente: "None of these three conditions appears to be in place at the moment."
Why contagion risks look contained
French private-sector borrowing costs have risen far less than sovereign yields. That allows blue-chip corporates such as LVMH and Airbus to borrow at yields below those of the French state. French domestic banks also hold only around 2% of total assets in domestic sovereign bonds, a fraction of the exposure held by lenders in Italy or Spain.
Policy is also different from 2010-2012. The European Central Bank has set up backstops, notably the Transmission Protection Instrument, to shield bystander countries from unjustified yield spikes. In addition, major member states outside Greece are posting balanced current accounts or surpluses.
The tail risk and the market outlook
Kenningham cautioned, however, that an open political confrontation between a future French government and EU authorities over deficit discipline could push spreads toward 400 to 500 basis points, resembling Italy's 2012 crisis. He characterized this outcome as a tail risk.
García Puente said European banks are far better capitalized today. Although their exposure to French debt may weigh on them in the short term, he said their fundamentals are solid and they are not a concern for Mapfre AM.
Source: Investing.com
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