Why has France's credit rating downgrade not provoked any reaction?

Economic

Summary:

Fitch’s downgrade of France to A+ drew no reaction as markets had priced in weak finances and political gridlock. Yields already surpassed peers, signaling loss of quasi-safe status for French debt.

Why do rating agencies wait until Friday evening to update their ratings, when everyone (at least in Europe) has already left for the weekend?

The idea behind this schedule is to give the markets time to "digest the news" and thus avoid overly harsh reactions at the opening. This objective has been perfectly achieved in the case of France.

On Friday evening, Fitch announced that it had downgraded France's rating from AA- to A+. And this morning, the CAC 40 opened up around 0.5%, while the French 10-year bond is at the same level as Friday, at 3.5%.

Lagging indicator

Beyond the timing, the lack of reaction mainly reflects the fact that this decision merely confirms a situation that is known to everyone, namely deteriorating public finances and the difficulty of taking measures to address the issue, given political instability.

Rating agencies are somewhat of a lagging indicator, and the market has already "done the work" when a downgrade occurs.

This is evidenced by the interest rate spreads relative to other eurozone countries. In recent days, the yield on 10-year French bonds has exceeded that on 10-year Italian bonds, even though Italy's credit rating (BBB) is several notches below that of France.

Prior to this, France was already borrowing at higher rates than Spain (whose rating was upgraded to A+ at the same time as France's downgrade), Portugal, and Greece. Conclusion: the market no longer considers France to be an AA country.

Why has France's credit rating downgrade not provoked any reaction?_1

Loss of status?

After Fitch, which is often considered a frontrunner amongst the rating agencies, Moody's and S&P Global will reassess their ratings in October and November. A downgrade is therefore likely, but we should not expect any more reaction than there was to Fitch's downgrade.

Fundamentally, the problem remains the same for France: passing a budget that reduces the deficit in a parliament that is divided into three blocs.

Will Sébastien Lecornu succeed where Michel Barnier and François Bayrou failed? Nothing is less certain, as the new Prime Minister does not have a stronger foothold in the French National Assembly. And a compromise seems difficult to find, especially since Jean-Luc Mélenchon, like Marine Le Pen now, is pushing for a new dissolution.

But there is no indication that a clearer majority would emerge from a new election. Political instability is therefore likely to continue, while the deterioration in public finances requires substantial measures. The public deficit is expected to reach 5.4% of GDP in 2025, the highest level in the eurozone.

All this comes at a time when Germany is expected to issue more debt to finance its recovery plan. For years, France benefited from the fact that Germany did not issue debt. Investors therefore had to turn to OATs. This additional demand helped to keep French interest rates down.

The risk-free status of OATs is already being called into question. According to an analysis by Goldman Sachs, several companies are now borrowing at lower rates than the French government, including L'Oréal, Airbus, and Axa.

Source: marketscreener

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