The euro zone, between French risk and German hope

The year 2024 is entering its home stretch, and it is an understatement to say that it will not have been very favorable to European stocks. When the S&P 500, the flagship index of the American stock market, rises at +27%, and even at +33% for an investor in euros thanks to the rise in the dollar against the single currency, the EuroStoxx 50 only progresses by 5%.

By Enguerrand Artaz, Fund Manager and Olivier de Berranger, CEO and co-CIO

From French political instability to the slump in industrial activity, including the exposure of many companies to a sluggish Chinese economy, the explanations for this underperformance are well identified. It is the question of perspectives that now arises. If of course – and, in a sense, unfortunately – the destiny of the euro zone will depend on China’s ability to finally revive its economy as well as on the Trump administration’s strategy of increasing customs duties, it will have to also live according to the adventures of its two engines: France and Germany.

On the French side, it is the risk of further slippage that predominates. Political instability will certainly continue for several more months. The scenario of an imminent fall of the Barnier government is gaining momentum, and if it were to happen, all scenarios would then be open, up to and including a potential resignation of President Macron. A context which could only further reinforce investor mistrust. Moreover, even a validated budget and the absence of a vote on a motion of censure would undoubtedly only have a marginally positive impact, with the prospect of a new dissolution next summer, and therefore the persistence of instability of power.

Furthermore, beyond the purely political aspect, the budgetary question will remain central. Even if the budget were passed, this would only reduce the deficit to 5% of GDP, which remains very high in absolute terms. In addition, this calculation is based on the hypothesis, recorded in the Finance Law, of GDP growth of 1.1% in 2025. Considering the recent evolution of economic indicators, this figure has very little impact. chance of being reached. Growth of around 0.5 to 0.7% seems more credible, with a significant risk of technical recession during the year. A budget calibrated on a growth hypothesis that is too high can only lead to further slippage. And unfortunately, the French situation is neither new nor exceptional. France is the State to have most often exceeded the excessive deficit threshold (3% of GDP) since the creation of the euro zone – 20 years out of 26. Moreover, it is today the worst student in the monetary union in terms of public deficit/debt ratio: Italy and Greece, whose debt/GDP ratio exceeds that of France, are in 2024 almost in budget balance for the first, in net surplus for the second .

Despite this lackluster record, and although the French 10-year rate recently exceeded its Greek counterpart, France continues to borrow at modest rates. But the risk is today real that the continuation of budgetary mismanagement, associated with political instability, will end up generating an attack of distrust such that rates soar on the markets, and that France knows, all things considered , a sort of debt crisis. This is undoubtedly where the main risk for the euro zone lies in the coming quarters.

This risk is, however, offset by hope coming from Germany, after the breakup of the ruling coalition. Barring a major reversal, the resulting early federal elections should be won next February by the CDU/CSU, led by Friedrich Merz. Tipped as future Chancellor, he will then make an alliance either with the SPD of Olaf Scholz or with the Greens, depending on the scores of these parties. Whatever the color of the next coalition, it seems certain that Germany, which has real room for maneuver with only 59% debt/GDP, without any primary deficit, will finally adjust its budgetary orthodoxy. Three credible avenues are available to her. First, ease the conditions and activate more frequently the safeguard clause which allows the Bundestag to suspend the debt brake.in the event of a natural disaster or other exceptional emergency situation beyond the control of the State[1]”. Then, renew the special fund of 100 billion euros created in 2022 to support the defense budget, or create a new one. Finally, review the budget deficit limit included in the debt brake mechanism. Fixed today at 0.35% of GDP, it could rise to 0.5 or even 0.75%.

These adjustments may seem minor. However, they would represent a major evolution in the state of mind of German leaders, and it is hardly credible, for the moment, to hope for more in the short term. In terms of investors’ perception of risk, this could be a breath of fresh air, the largest economy in the euro zone finally taking stock of an economic model that has been in decline for almost a decade and showing itself capable of providing a little flexibility to his sometimes frenzied ordo-liberalism. This could also restore momentum to certain cyclical sectors shunned by the markets, such as automobiles or chemicals.

A large part of the stock market fate of the euro zone in 2025 will certainly depend on the occurrence of a French peril or the materialization of – reasonable – German hope.

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