MORGAN STANLEY RECOMMENDS SHORT FRENCH DEBT TRADE
French government bonds have been underperforming peers for the past few weeks, as worries about gridlocked French politics and the country's high deficit resurface, and Morgan Stanley think this trend can continue.
They recommend investors go short France against an equal weighted basket of Italian and German debt, and anticipate around 10 basis points of French underperformance in the coming months.
France's 10-year yield (FR10YT=RR) was last 3.75%, back just above Italy's TVC:IT10Y and around 78 basis points above Germany's (DE10FR10=RR) — that gap has widened around 18 bps since late May.
Morgan Stanley attribute this rise to worries about France's fiscal situation. The country's hung parliament has struggled to pass a budget for the past two years, and we're approaching the build up to the budget process for 2027.
The 2027 presidential election adds a further complication, and, on Tuesday, France's Finance Ministry cut its 2026 growth forecast to 0.7% from a previous 0.9%.
Investors are accustomed to fraught budget processes, but, say Morgan Stanley, "concerns showed up earlier than they did last year and, in our view, are likely to remain a source of pressure."
There are some other factors in France's recent underperformance.
Morgan Stanley say the political risk premium in French debt, which was elevated for much of 2025, faded at the start of the year after the passing of the 2026 budget, and this "left less cushion in valuations, making France more vulnerable as fiscal concerns resurfaced."
As well, France was less exposed than Italy to Middle East oil and gas, and so after the Strait of Hormuz reopened investors rebalanced their relative exposure to French and Italian debt.