Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Mr. Credit is fueling France’s growth
Christopher Dembik
Head of Macroeconomic Research
Summary: France’s economy will be more resilient this year than the rest of the eurozone due to a strong inflow of credit and fiscal stimulus. However, the country has not fully taken advantage of the low-interest rate environment to move upmarket and we fear that layoff plans are coming in industries that are most vulnerable to the international context.
In the coming months, France’s economy will continue to outperform the rest of the euro area, especially Germany. We expect growth to reach 1.2% in 2019 versus 1.3% according to the latest update of the Bank of France. This positive trend is mostly due to four factors: strong inflow of credit, less international exposition, fiscal stimulus, and better household confidence.
Credit remains a key driver fueling the economy, like in previous years.
The 3-month moving average of bank loan growth is close to its post-crisis high, at 5.3% YoY in May. Looking at the flow of new credit, which leads the real economy by 9 to 12 months and is therefore an important leading indicator of GDP growth, the picture is also bright. Based on our proprietary model, the flow of new credit reached 1.32% of GDP in Q1 2019, which is way above the average of the eurozone, at 0.47%, and higher than Germany which stood at 0.41%. As we can see in the chart below, the impulse of new credit is highly correlated with the INSEE business survey, which is itself one of the most reliable leading indicators of the French GDP (R^0.90). The survey is well-oriented, moving upwards at 105.9 in Q2 2019, confirming our positive macroeconomic view for the French economy in the short and medium-term.
Credit remains a key driver fueling the economy, like in previous years.
The 3-month moving average of bank loan growth is close to its post-crisis high, at 5.3% YoY in May. Looking at the flow of new credit, which leads the real economy by 9 to 12 months and is therefore an important leading indicator of GDP growth, the picture is also bright. Based on our proprietary model, the flow of new credit reached 1.32% of GDP in Q1 2019, which is way above the average of the eurozone, at 0.47%, and higher than Germany which stood at 0.41%. As we can see in the chart below, the impulse of new credit is highly correlated with the INSEE business survey, which is itself one of the most reliable leading indicators of the French GDP (R^0.90). The survey is well-oriented, moving upwards at 105.9 in Q2 2019, confirming our positive macroeconomic view for the French economy in the short and medium-term.
France is less exposed than Germany to negative global trade growth trend, China’s slowdown and Turkey’s credit crunch.
The fiscal stimulus of about 10 billion USD in response to the Yellow Vest protests along with the 5 billion tax cuts have lifted consumption. Though some have been directed, as it is traditionally the case in France, to precautionary savings, it will serve as a cushion in 2020 when the expected deterioration of the international situation will impact more the French economy.
Households are slightly more confident regarding the future. Based on the latest INSEE consumer confidence survey of June, only 16% of respondents declared they are afraid of rising unemployment in the next twelve months versus a peak reached 32% in past January.
The fiscal stimulus of about 10 billion USD in response to the Yellow Vest protests along with the 5 billion tax cuts have lifted consumption. Though some have been directed, as it is traditionally the case in France, to precautionary savings, it will serve as a cushion in 2020 when the expected deterioration of the international situation will impact more the French economy.
Households are slightly more confident regarding the future. Based on the latest INSEE consumer confidence survey of June, only 16% of respondents declared they are afraid of rising unemployment in the next twelve months versus a peak reached 32% in past January.
The bottom line is that France has not yet fully taken advantage of the current low-interest environment to innovate. We fear that, at the microeconomic level, some sectors could be hurt hard in coming months due to negative external headwinds.
Over the past years, many parent companies have borrowed money at low cost on the financial market to finance subsidiaries abroad that did not benefit from such favorable financing conditions, which largely explains the sharp rise in gross indebtedness of French companies (roughly estimated to 175% of GDP according to S&P Global Ratings). However, this increase in debt also hides a growing and intense activity of mergers and acquisitions, which has been detrimental to investments in research and innovation. France’s inability to move upmarket essentially explains its difficulties to gain market share abroad. This M&A risk-taking strategy could even weaken companies that are not able to fully integrate new entities _ leading as we all know to higher costs in the short term _ before the next economic crisis will pop up. On the top of that, in the country of Socialism, it underlines the increasing power of shareholders on top management’s strategy and the quest for short term high returns which are often at the expense of long-term investment strategy.
Partially related to the inability to adapt to the production of goods to the best international standards, we fear that some industrial sectors will be very vulnerable to current downside risks to global growth. The feedback we have from leading lending institutions financing industrial projects in France and from local businessmen is that some industrial sectors may face heavy layoff plans in coming months if the global economic situation does not improve substantially. The main area of tensions is concentrated in the automotive industry and especially at the level of suppliers and service providers. If this risk materializes, we doubt that the government will be able to react appropriately and efficiently. The French government’s track record to deal with massive industrial layoff plans is not very good and things have not really changed with the current government, especially because it has not been able so far to formalize a coherent and sound industrial policy for the country. Finally, Macron’s low political capital since the Yellow Vest crisis will constitute a constraint on the government’s actions, whether to implement new reforms or deal with economic challenges.
Over the past years, many parent companies have borrowed money at low cost on the financial market to finance subsidiaries abroad that did not benefit from such favorable financing conditions, which largely explains the sharp rise in gross indebtedness of French companies (roughly estimated to 175% of GDP according to S&P Global Ratings). However, this increase in debt also hides a growing and intense activity of mergers and acquisitions, which has been detrimental to investments in research and innovation. France’s inability to move upmarket essentially explains its difficulties to gain market share abroad. This M&A risk-taking strategy could even weaken companies that are not able to fully integrate new entities _ leading as we all know to higher costs in the short term _ before the next economic crisis will pop up. On the top of that, in the country of Socialism, it underlines the increasing power of shareholders on top management’s strategy and the quest for short term high returns which are often at the expense of long-term investment strategy.
Partially related to the inability to adapt to the production of goods to the best international standards, we fear that some industrial sectors will be very vulnerable to current downside risks to global growth. The feedback we have from leading lending institutions financing industrial projects in France and from local businessmen is that some industrial sectors may face heavy layoff plans in coming months if the global economic situation does not improve substantially. The main area of tensions is concentrated in the automotive industry and especially at the level of suppliers and service providers. If this risk materializes, we doubt that the government will be able to react appropriately and efficiently. The French government’s track record to deal with massive industrial layoff plans is not very good and things have not really changed with the current government, especially because it has not been able so far to formalize a coherent and sound industrial policy for the country. Finally, Macron’s low political capital since the Yellow Vest crisis will constitute a constraint on the government’s actions, whether to implement new reforms or deal with economic challenges.
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