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Niall McDermott's view on: Why Macron’s roll of the dice is too risky for our portfolio

Marlborough Global Bond Co-Manager Niall McDermott explains why he and James Athey have sold out of the bonds of most European Union governments and reinvested the proceeds in German government bonds, as a defensive move after the surprise announcement of an election in France.


French President Emmanuel Macron’s gamble in calling a snap election following his party's dismal results in the elections for the European Parliament focused investors’ attention on the nation.

France’s rather dismal economic health and the spectre of political change were thrust into the limelight and investors could not ignore the situation.

Polls suggest that far-right and far-left parties will emerge as the big winners from Macron’s gamble. With fiscal discipline already notably absent and both far-right and far-left politicians proposing to turn on the spending taps, bond investors quickly feared the worst and voted with their feet.

The snap election had heightened the focus on France’s poor growth and debt dynamics, of which we had long been aware. Many investors have now lost faith in the French economy and the cat is not going to go back into the bag anytime soon. Investors moved their capital – divesting away from the nation – and we were among them.

We took the decision to sell out of French, Spanish, Italian and Belgian government bonds and move most of the proceeds into German government debt.

While ultimately, we expect the dust to settle at some point, we do expect volatility to be heightened and the risk is that things get worse before they get better. At this late stage in the economic cycle, we want to be positioned defensively. In our view, it is not so much a question of if things will break, but when. In that respect our short-term and long-term views are closely aligned with respect to a desire to reduce exposure to risky assets.

For us, that meant selling all of our French government bonds. However, we also sold out of Spanish, Italian and Belgian government debt because correlation between non-core Eurozone government bonds remains high and indeed debt metrics across the region are of concern.

The elections to the European Parliament took place between 6th and 9th June. On Friday 7th June we had just over 9% of the portfolio in the bonds of the French, Spanish, Italian, Belgian and German governments. Our holding in German government bonds was just under 0.5% of the fund. By close of play on Monday 10th June, just over 8% of the portfolio was in German government bonds, with the rest of our EU government bond positions sold and the outstanding balance held as cash.  

Our decision to invest into German bonds represents our assessment that the country’s relative fiscal responsibility and low debt burden will see it earmarked by European investors as the Eurozone’s only safe haven and as such we would expect German bonds to be a main beneficiary if the difference in yields paid by different Eurozone governments widens.

With France’s national deficit and debt levels entrenched on what we believe is an unsustainable path, the risks grow of an unstable new government, lacking the ability to make decisions – or spending like there is no tomorrow. And with Eurosceptic voices increasing in volume in France, we believe this could also potentially increase the risk of an EU break-up.

The challenges facing France are significant – we have highlighted a number of them in the charts below.

Story in charts – France is struggling

Investors have penalised France by increasing the relative cost of borrowing, through the sale of French bonds in favour of the perceived safety of German government bonds, as fears simmer about another Eurozone debt crisis.

French government spread (Bps) over Germany

Source: Bloomberg

The EU bloc has a stability and growth pact. This states that EU member states should not have a budget deficit greater than 3% and a maximum public-debt-to-GDP ratio of 60%. France’s ratio has been significantly higher than this for well over a decade. France’s left-wing parties have said they have no intention of following this rule and the far right have historically made noises about leaving the EU.

France's unsustainable debt to GDP ratio (%)

Source: Bloomberg

The relative story also paints a bleak picture for France. Its debt levels have remained elevated and closer to that of the perceived ‘riskier’ Italy than that of Germany.

Government Debt to GDP (%)

Source: Bloomberg

Furthermore, while Italy has been running a primary surplus (meaning that excluding interest payments the Italian government is currently earning more in tax revenue than it is spending) France remains mired in a large, late-cycle budget deficit even when excluding interest payments.

Primary budget balance as % of GDP

Source: Bloomberg

France continues to spend more than it is able to raise in tax revenue and overall, its expenditure represents almost 60% of GDP – a significantly higher proportion than comparable economies. Fiscal discipline is absent, with debt spiralling to support economic growth in the short term, pay a rising interest bill and ultimately feed more and more debt. Now with the cost of this debt pile rising, concerns are growing among investors – because as the cost increases, even more debt is needed to fuel the already growing interest payments. This risks creating a ‘doom loop’ of debt, which attracts more scrutiny from investors, causing borrowing costs to rise and the chaos to continue.

Expenditure as % of GDP

Source: Bloomberg

This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.