Positions in Europe: Short France (EWQ)
Keith shorted France via the eft EWQ in the Hedgeye Virtual Portfolio today. We opportunistically shorted EWQ from a quantitative set-up with the CAC 40 broken on its long-term TAIL and intermediate-term TREND lines (see chart below).
France remains an important EU country in the crosshairs—constrained by fiscal pressures (debt and deficit) and a web of cross-country sovereign banking exposure, the two combined put pressure on the country’s AAA credit rating. On 10/18 we penned a note titled “France is Going to Get Downgraded”, and made the important point that there exists an enormous outsized risk to the entire European bailout project for sovereigns and banks should France lose its credit rating: essentially the entire EFSF would be jeopardized, as France is the second largest contributor of collateral to the facility, at 20%, behind Germany at 27%.
From the fiscal side, France’s public debt as a % of GDP is likely to hit 88.4% this year, near the important 90% (and above) level that Reinhart and Rogoff outline in their seminal book This Time is Different as prohibitive to growth. Through austerity, the government hopes to bring down the budget deficit, forecast to hit 5.7% of GDP this year, to 3% in 2013, or in compliance with the EU’s Growth and Stability Pact. Nevertheless, there’s been great push-back to Sarkozy’s austerity programs (including the most recent €8 Billion in additional budget cuts), which has also eroded his polling results for elections next April.
In response, last week the government came out and revised GDP to 1.0% in 2012 versus a previous estimate of 1.75%. Politically, Sarkozy remains faced with high unemployment, at 9.2% (vs 7% in Germany), or 22.8% among the French youth, and unlike Germany does not have the ability to cushion slowing growth through exports.
As a risk signal, we continue to follow the spread between German bunds and 10YR French yields, which today reached an all-time high of 125bps since the creation of the EUR.
Matthew Hedrick
Senior Analyst