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Podcast: Jump Start – tech catalysts, Fed cuts, and French politics (5 min)
Video: CIO's Wayne Gordon on the gold rally (2 min)
Video: Equity opportunities in a rate-cut environment (8 min)

French Prime Minister (PM) François Bayrou faces a no-confidence vote this afternoon, with opposition parties across the spectrum signaling their plans to oppose his minority government. Should Bayrou lose, he will be required to resign. Our base case is that President Macron will then appoint a new PM, likely someone closer to center-left Parti Socialiste. Failing this, Macron could either dissolve parliament and call for new elections, or retain Bayrou as caretaker PM until a consensus successor candidate emerges.

Political uncertainty in France has been driving volatility across the country's credit, equity, and currency markets. The potential fall of the Bayrou government would increase the risk of downgrades by major rating agencies, with a potential Fitch decision as early as 12 September. France’s fiscal deficit has been a key concern, standing at 5.5% of GDP, nearly double the EU’s 3% limit, while budgetary pressure is worsening as public debt nears 114% of GDP.

While there is a risk short-term volatility may pick up following the vote, we suggest investors avoid a kneejerk reaction:

French political uncertainty is no longer a surprise. France’s elevated deficit and debt levels have been flagged by rating agencies for some time, with the risk of a sovereign downgrade at least partially priced into bond spreads. The structural drivers behind this, from high social spending and generous pensions to persistent health care outlays, have long been understood by investors. Periods of political turmoil in France have historically produced only temporary market moves, and we anticipate the same this time, especially in our base case scenario where a new PM and government is formed and the risk of a snap election recedes.

Regardless, we anticipate less painful fiscal consolidation. The fiscal tightening planned for 2026 will likely be less than the EUR 44bn (USD 51.6bn) initially proposed by Bayrou. The July budget draft would have been consistent with the deficit falling to 4.6% of GDP in 2026, with a longer-term target of 2.8% by 2029. We instead expect the deficit to narrow more modestly to 5% next year, and we think the European Commission is likely to accept a more gradual fiscal tightening path after that.

France’s government debt remains affordable. On a net basis, France only spent 3.6% of annual revenues on debt service last year. The average tenor of its bonds is 8.1 years and the average coupon is 1.85%, meaning that low yields from the past have been locked in for a long time. This is slowly climbing, with large fiscal deficits being funded at current average market yields of 3.1%, and maturing bonds that need to be refinanced often carrying coupons of less than 1%. We expect the net cost of debt to rise to 4% of revenues this year and to reach 5% by 2027, a level roughly in line with Spain.

So while we advise against holding long-dated French government bonds (OATs) given continued upward pressure on yields, we do see value in shorter-term French government bonds in the 2-5-year bracket, where instruments are already offering a premium over Italian counterparts. At the 5-8-year part of the curve, we currently favor French covered bonds over OATs. Within corporate bonds, French multinationals remain preferable to domestic banks, given their diversified revenue streams, global footprint, and lower exposure to fiscal headwinds, and we would use any pronounced sell-off as a potential entry point for opportunistic, longer-term-oriented investors.

If the Bayrou government fails, we would expect any euro weakness to be temporary, with levels around 1.14-1.15 offering a compelling entry point for investors targeting a year-end EURUSD rebound toward 1.21. For equities investors, we wouldn’t rule out lingering overhang on French domestic stocks due to the still-challenging fiscal situation and lack of clear political majority. Looking more broadly within European equities, we like Swiss high-quality dividends, European quality stocks, European industrials, and our “Six ways to invest in Europe” theme.