Weekly Update - France: why markets are underperforming those in the euro area

Since the beginning of 2024, French financial markets have posted positive but lower performances than those in the euro area, both in terms of equity and bond markets. This underperformance can be explained by a combination of factors: a relatively average economic situation, fears about the trajectory of public finances leaving less support capacity and a less favorable sector composition.
 
Positive performances but less than the rest of the euro area. Since the beginning of 2024, the French equity market has posted a performance of +10%, while the German, Italian and Spanish markets have exceeded +40% (calculation based on broad indices, with dividends reinvested). At the same time, the French bond market posted a cumulative performance of +2% over the same period, significantly lower than that of the Spanish and Italian markets (respectively close to +5% and more than +7%). The French bond market is penalised both by a lower level of interest rates than in Italy (carry effect), but also by an interest rate that has remained almost stable over the period, while they have fallen sharply in Spain and Italy (value effect).
 
The economic situation is in the average, but the trajectory of public finances stands out. On the activity momentum front, the French economy appears to be in line with the euro area average, with cumulative growth of +1% since January 2024, while Spain is clearly outperforming (+4%) and Germany appears to be lagging behind (0%). On the other hand, France stands out from its neighbors by the recent trajectory of its public finances. The European Commission points out that the deficit will remain above 5% in France in 2025, while it will be around 3% in the main economies of the euro zone. Looking without the interest charge, the primary deficit also remains much worse for France, particularly compared to Italy, which has a positive primary balance as of 2024, a sign of significant fiscal efforts. This context, combined with the French political context without a clear majority since the surprise parliamentary elections in June, is weighing heavily on the bond markets and contributing to the weaker performance on the equity markets
 
European fiscal support plans are only indirectly favorable to the French economy. First, the "Next Generation EU" plan, put in place following Covid, will continue to favor mainly Spain and Italy in the coming quarters. Indeed, France benefits from a smaller total envelope and has already used a large part of the available funds. In parallel, the RearmEU plan could support the French arms industry, but indirectly and with a certain delay. Finally, Germany has announced a "whatever it takes" that will first and foremost support its own economy. In short, these European plans will have a modest direct effect on the French economy. However, they could improve the dynamics of the market indirectly, by stimulating growth in its trading partners in the immediate vicinity
 
A less favorable sector composition. Beyond the macroeconomic effects, the French equity market remains penalized by a sector composition that distinguishes it from other markets. First, the consumer sector, and particularly the luxury sector, appears to be over-represented compared to other neighboring markets. However, this sector is affected by the sluggishness of Chinese demand but also by the threat of tariff increases. In addition, the financial sector represents a small weight (13% compared to 23% for the euro zone and more than 40% for Spain and Italy), while this sector has been the best performing since the beginning of the year.
 
Other highlights of the week
 
In the highlights of the week, we chose to talk about Uncertainties over tariffs and investments in the United States and the Inflation & Monetary Policys in the US and in Europe.
 
Uncertainties over tariffs and investments in the United States
On Wednesday, the United States Court of International Trade (ITC) suspended the tariffs decided by the Trump administration, ruling that the President had exceeded his prerogatives. However, on Thursday, an appeals court suspended the decision, pending the judgment on the merits. Tariffs therefore continue to apply for the time being. At the same time, a provision in the draft budget voted last week by the House of Representatives adds a new element of uncertainty. "Section 899", which has so far gone relatively unnoticed, targets countries that apply, according to the United States, "unfair foreign taxes". This section provides for a fivepercentage-point increase, over four years, on taxes related to dividends and interest from U.S. stocks and certain corporate bonds held by foreign investors. In addition to discouraging foreign investment in the United States, this measure could also weigh on the dollar, which has already fallen by 9% against the euro since the beginning of the year. In this context, the S&P 500 and Nasdaq indices, which had almost returned to their level at the beginning of the year, could be weakened again. However, the Senate still has to vote on this draft budget.
 
Inflation & Monetary Policy. In the euro zone, inflation rates continued to fall in May, to 0.6% in France, 2.1% in Germany, 1.9% in Italy and Spain over one year. These figures are in line with wage trends, which showed a clear slowdown in the first quarter. Inflation figures for the whole euro area will be known next Tuesday, but markets are already anticipating a further rate cut by the European Central Bank next week (5 June) as well as another in the coming months. In the United States, the PCE index for April remained stable at 2.1%. Similarly, the Core CPE, which excludes energy, food and tobacco, also remained stable at 2.5%. But caution remains the order of the day, with household and business surveys pointing to a rise in prices, while the impact of tariffs could be felt in the coming months. The Federal Reserve would remain wait-and-see in this context, with markets anticipating a status quo for the next monetary policy meeting on June 18.

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