rejecting the budget would affect the credibility of France and investors

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The author is managing partner and head of research at Axiom Alternative Investments

Markets are used so much to deal with the fear of frequent shutdowns in Washington that US government agencies sometimes rise in such conflicts, even because the Treasury is considered a place of refuge in times of turmoil. But the markets should not give France such an opportunity if the current disagreement over the national budget leads to a rejection by the parliament.

We have had a glimpse of how to deal with the French government’s yield spread on German debt, which is growing to its highest level since the Eurozone crisis. At one point, the yield on the benchmark French bond rose slightly above that of Greece.

But first, is the closure of France an event? Because of the complicated political calculation, I don’t know if the French budget will get it approval of the parliament. Prime Minister Michel Barnier could put in place a “take it or leave it” constitution, a negative 49.3 article, which allows the government to control lawmakers. But this could lead to a vote of no confidence in the parliament and if lost, the budget would be rejected.

What happens if the budget is rejected? There is a lot of controversy over the law France around this – and this is the first big problem. Markets hate negative events. If no one can clearly explain how the process is going and the government money being paid for, this is a concern.

The main problem is that the main parts of the constitution – article 47 and article 45-4 of the financial law – mainly relate to the delay of the proposal or voting budget. There is no clear rule on budget rejections, except that no debt can be incurred without the consent of the parliament. A similar case occurred in 1979-1980 and was settled by a last-minute order and a federal court decision.

Obviously, the political cost of rejecting the budget will increase with the fear of lack of wages, but with the ongoing political protests, the risks and challenges are greater.

There is, however, one “get out of jail free” card. Under the 16th chapter of the constitution, President Emmanuel Macron can – possibly – declare that the continuity of France is at risk and implement the budget by presidential decree. This “threat” may be enough to ensure that no shutdown occurs, and that the legislature has every incentive to find a solution, even if only temporarily.

But all of this will not go well with the markets. Two rating agencies have already put France on a negative outlook. A legal problem can cause an early decline. With French bonds rated minus A and S&P already trading and B minus triple rated Greek debt, I expect the cut to be reversed.

As for the French banks, I calculate about 93 percent of the indicators that are stored “at value” and therefore, cannot be compared to the volatility of the market. So banks can wait for a long-term solution instead of managing any losses by selling.

I also do not think that the European Central Bank or the European Commission will change. The committee has agreed to the proposed budget for France, and I do not expect it to comment until it is approved by parliament. As for the ECB, the final arbiter of the Eurozone’s government bond markets, fears of a shutdown could provide a reason to support the market and support bond prices. But the ECB may wait for a little more instability to get French politicians to act before stepping in.

Investors are a different story. Long-term investors, “real money” in government double A (think life insurance companies, Japanese banks and so on) hate uncertainty. They want unpleasant, predictable returns. And short-term, speculative investors tend to play on fear and bias. The main issue with a failed budget will be very difficult. Political turmoil, without a stable government, will make communication more difficult and markets more volatile. The long-term damage to market integrity can be significant.

So let’s not fool ourselves: going into the new year without a budget, and with the administration trying to explain that the debts will be paid in some way, it will remind the French people of the famous words in the film of Mathieu Kassovitz, Hatredtells the story of a man who fell from a 50-story building: “So far, so good. But the important thing is not to fall, but to land.” The good news is that the EU has always been better at managing the slide than the fall.

Axiom has an investment position in the European and French stock markets