French government bond spreads have returned to levels last seen during the euro zone debt crisis. A market strategy note argues the stress stays concentrated in a few countries, which could limit how far the ECB tightens, and it accompanies a strategy favouring a weaker euro.
French bond spreads have returned to levels last seen during the euro zone debt crisis, but broader European stress indicators have yet to show comparable strain. A market strategy note says the pressure is concentrated in a handful of countries rather than signalling a wider deterioration across European markets.
France and Belgium carry the most risk
The note argues that France and Belgium are the region's most vulnerable sovereign borrowers. However, it says their weaknesses remain less severe than those of stressed European economies during the 2011 debt crisis.
Some spillover is likely, yet the pressure may remain largely confined to France. That could limit the need for a more aggressive response from the European Central Bank.
Election leaves little room for relief
The outlook for French bonds remains uncertain, with limited scope for meaningful relief ahead of the country's election. Continued pressure on sovereign spreads could therefore leave the ECB unable to raise interest rates as aggressively as financial markets currently anticipate.
Beyond rates, the strategy favours a weaker euro. It recommends positions that sell the currency against a basket of Group of 10 currencies, where investor positioning is less stretched than against the U.S. dollar.
Equities and Brazil
Despite the risks around French debt, the strategy sees improving seasonal conditions for equities. It expects the most supportive period in November and December rather than immediately, and it keeps a long position in U.S. equities while adding exposure to Brazil.
Source: Investing.com
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