Keith covered France via the eft EWQ and EUR-USD via FXE in the Hedgeye Virtual Portfolio today with the CAC40 approaching our oversold level of 2,801 and EUR-USD approaching our oversold level of $1.32. We opportunistically covered EWQ, however remain bearish on the country over the long term TAIL duration (see chart below). The CAC40 is down -28% since its end of June high. We took the other side of Goldman Sachs currency analyst Thomas Stolper’s bullish call on the EUR-USD on November 11th and shorted FXE in our portfolio. We’ll cover here with Goldman capitulating on the call today and the cross approaching our $1.32 line, but remain bearish on the Euro's intermediate-term TREND.
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. Today, Fitch Ratings warned that France’s AAA credit rating would be at risk if crisis intensifies.
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 22%, behind Germany at 29%.
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.
On the banking side, France is the largest holder of Italian public debt ($106.8B) and private debt ($309.6B) of any country according to June BIS report, which compounds risk given Italy’s own debt imbalances and investor uncertainty around leadership in the wake of Berlusconi.
Early this month Sarkozy’s government 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.
Matthew Hedrick
Senior Analyst
