France to Underperform as Downgrade Risk Rises

French President Macron has backtracked in the face of increasingly violent protests against his policies. While this may provide a temporary calm, we believe France will remain under pressure as protests continue and the macro backdrop worsens.


The so-called Yellow Vest movement in France is not associated with any particular party or trade union. Rather, it is a grass roots protest that sprang out of the poorer towns and villages in France. Polls show anywhere from 75-85% support nationwide for the Yellow Vests.

In the face of Yellow Vest protests, President Macron canceled the planned fuel tax hike. Whilst ostensibly meant to discourage reliance on fossil fuel use, the tax would have hurt the rural populations more than the urban elite. As such, the fuel tax came to signify more of a class struggle than what was originally intended.

As the protests continued even after the tax reversal, Macron went even further and announced a big dose of fiscal stimulus. The measures include (but are not limited to) hiking the minimum wage, abolishing taxes on overtime pay, and eliminating a controversial tax on pensions. Yet Macron’s popularity continues to fall, barely registering near 20%.

Macron was elected to a five-year in May 2017 on a platform of reform. He won handily in the run-off vote against Marine Le Pen. Parliamentary elections were then held in June 2017, where his En Marche! allied with the centrist Democratic Movement to win 350 seats out of 577 total. Indeed, En Marche! alone won a majority with 308 seats. Outgoing President Hollande’s Socialist Party won only 30 seats, while former President Sarkozy’s Republicans (formerly Union for a Popular Movement) did somewhat better with 112 seats.

Early in his term, Macron gave breaks to businesses and cut corporate and wealth taxes. He embarked on an effort to reform labor laws, making it easier to lay off workers and to give greater flexibility to negotiate with labor. That is why he has come to be viewed as a president that cares more for the rich than for the working poor. Now, the government has announced spending cuts and corporate tax hikes to help pay for the increased social spending.

The next presidential election is due in 2022. Parliamentary elections will follow shortly thereafter. A lot can obviously happen before now and then, but it remains to be seen whether Macron can recover from current events. We suspect the public will not take to kindly to his efforts to basically pay them off with fiscal goodies. Protests are likely to continue.



The current protests are the worst for France since those that rocked the nation in May 1968. Then, a student revolt that began in the suburbs spread to consume the entire country. Much has been written about the causes, but most accounts center on youthful rebellion against an increasingly unpopular and authoritarian government.

Wartime hero General Charles de Gaulle was elected President by the electoral college in 1958 after the collapse of the Fourth Republic that year. During the so-called Fifth Republic, de Gaulle amended the constitution in 1962 to allow direct elections for the presidency. He won a second 7-year term in 1965. Under de Gaulle, French society was considered to have become very conservative and religious.

The protests began at the suburban Nanterre campus of the University of Paris, ostensibly over strict socialization rules between male and female students. When authorities closed that campus in response, the protests moved to the Sorbonne campus, in the heart of the Latin Quarter. When authorities closed the Sorbonne campus, the protests escalated. By early May, the number of student protestors in Paris had swelled to tens of thousands. As a result, the responses became more heavy-handed. This helped the protests spread in popularity, with several major unions engaging in a one-day general strike in support of the students.

Those strikes quickly spread across the country. Officials quickly buckled, offering significant increases to the minimum wage and other salaries. Yet the protests didn’t stop. Many students began chanting “Adieu, de Gaulle!’ Reports suggest de Gaulle, fearing a revolution, fled temporarily to Germany before he was convinced to return to France.

On May 30, de Gaulle called for new elections and hinted at a potential military response to the demonstrations. This seemed to stop the momentum of the protestors. Workers started to return to their jobs, while the national student union called off any more street demonstrations. The police retook the Sorbonne campus on June 16. Surprisingly, de Gaulle’s party swept parliamentary elections on June 23, winning 353 out of 486 seats. The Communists won 34 and the Socialists won 57 seats.

Yet de Gaulle’s time had passed. Despite his party’s successful showing in the elections, de Gaulle himself had become deeply unpopular. He resigned on April 28, 1969 after his national referendum on government reforms was rejected by the voters. He died suddenly and unexpectedly on November 9, 1970.



Growth is slowing. GDP growth is forecast by the IMF at 1.6% in both 2018 and 2019 vs. 2.2% in 2017. GDP rose only 1.4% y/y in Q3, down from the 2.8% peak in Q4 2017 and the weakest since Q1 2017. As such, we see downside risks to the forecasts. Indeed, ECB President Draghi just cut the growth forecasts for the entire eurozone for 2018 and 2019.

Price pressures have eased. CPI rose 1.9% y/y in November, the lowest since April. Price pressures are likely to continue easing in the coming months. ECB President Draghi also just cut the inflation forecasts for the entire eurozone for 2018 and 2019.

The fiscal outlook has worsened. Even before this latest about-face from Macron, the budget deficit was expected by the OECD to widen next year to -2.9% of GDP from -2.7% of GDP in 2018. In light of the fiscal stimulus just announced, we think the deficit will easily surpass -3% and move closer to -3.5% of GDP next year.

Can France avoid an excessive deficit procedure? The EU has been largely silent on the matter since Macron unveiled his plans. Yet consider how quickly the EU criticized Italy for its 2019 draft budget that called for a deficit equal to -2.4% of GDP. Italy’s debt to GDP ratio is 130% this year compared to 97% for France. However, France’s budget deficit is likely to be wider than Italy’s for the next several years. It’s hard to see how the EU can justify giving France a pass on this latest turnaround by Macron.



The euro is performing in the middle of the major pack after a stellar 2017. In 2017, EUR rose 14% vs. USD and was the best major performer, followed by SEK (11.5%) and GBP (10%). So far in 2018, EUR is -5% and compares to the best performers JPY (-1%) and CHF (-2%) as well as the worst SEK (-10%) and AUD (-7%). The ECB is tilting more dovish. Taken in conjunction with fiscal slippage by France and Italy, we expect the euro to start underperforming more.

EUR has traded largely in the $1.13-1.14 this month. A daily trendline drawn off the November 12 low comes in currently around $1.315. Break below that trendline would target that November low near $1.1215.

French equities continue to underperform within the Developed Markets. In 2017, MSCI France was up 12% vs. 20% for MSCI World. So far this year, MSCI France is -7.5% YTD and compares to -6.5% YTD for MSCI World. We expect French equities to continue underperforming.

French bonds have outperformed within the eurozone this year. The yield on 10-year government bonds is -5 bp YTD. This is behind only the best performers Portugal (-21 bp), Germany (-14 bp), Spain (-13 bp), and the Netherlands (-9 bp). With concerns about the budget deficit likely to pick up further, we think French bonds will start to underperform more.

Considering Macron’s volte-face, we ran updated budget and debt numbers for France and the results aren’t pretty. Our sovereign ratings model already showed France’s implied rating falling a notch to AA-/Aa3/AA- back in October. With updated numbers, we have France falling another notch to A+/A1/A+ so there are clearly downgrade risks building up to actual ratings of AA/Aa2/AA.