10-Year French Bond Yield, French-German Spread, French CDS, and CAC 40 Haven't Moved Much Since Mid-December; French Manufacturing Continues To Diverge With Eurozone

France's manufacturing sector continues to deteriorate, according to Markit's France Manufacturing PMI (final) for December (released January 2, 2014):

French manufacturers signalled a further deterioration in operating conditions during December. The headline Purchasing Managers’ Index® (PMI®) – a seasonally adjusted index designed to measure the performance of the manufacturing economy – dropped from 48.4 in November to 47.0, its lowest level in seven months. The PMI was dragged down by four of its five components in the latest survey period, as output, new orders, employment and stocks of purchases all decreased at sharper rates. Only suppliers’ delivery times (inverted in the calculation of the PMI) acted to boost the level of the headline index, lengthening to a greater extent in December. 

Here's a look at Markit's France Manufacturing PMI versus the INSEE Manufacturing Production year-over-year growth rate (France's official number).

Source: MarkitEconomics.com (Markit France Manufaturing PMI)

Jack Kennedy, Markit's Senior Economist and author of the report, sees no turnaround in sight for French manufacturing:

“The French manufacturing sector ended the year in disappointing fashion. Sharper falls in both output and new orders drove the PMI down to its lowest level in seven months, as a weak demand climate continued to weigh heavily. Anecdotal evidence suggested that lingering uncertainties continue to hold back the spending and investment that are necessary to support a recovery in the sector. Instead, most key variables in the latest PMI survey showed deteriorating trends to suggest that no such turnaround is in sight.

What's interesting is France is now the economic buzz-kill of the Eurozone. According to Markit's Eurozone Manufacturing PMI (final) for December, Eurozone manufacturing grew at its fastest pace in over 2.5 years.

The recovery in the eurozone manufacturing sector accelerated further at the end of 2013. The seasonally adjusted Markit Eurozone Manufacturing PMI® rose for the third month running to post 52.7 in December, up from 51.6 in November (and unchanged from the earlier flash estimate).

The headline PMI has now signalled expansion throughout the second half of the year. For the final quarter as a whole, the sector is recording its best performance in two-and-a-half years, consistent with a quarterly pace of output growth of around 0.6%.

Here you can see that France is clearly diverging with the rest of the Eurozone. Even Greece.

Source: MarkitEconomics.com (Markit Eurozone Manufacturing PMI)

On December 18, 2013, I mentioned that hedge fund managers and strategists were starting to get bearish on French government bonds. France's economic downturn, "constrained fiscal flexibility" (S&P), rising debt ratios, and tapering by the Fed could cause French bonds to sell off and yields and debt service payments to rise, which would hurt the French economy even more. Bridgewater's Ray Dalio was not optimistic on France at the 2013 DealBook Conference. He said:

As debt rises faster than income, which is continuing in France, and interest rates - both the base rate and the credit spreads have gone down to a certain level that they can't decline anymore - there's going to be a rise in debt service payments in France. And those rise in debt service payments are going to have an increasing constrictive nature on the economy. It's going to start to hurt that particular economy. At the same time, there's the rollover of debt. A lot more debt needs to be rolled over because it builds up and it compounds. And when it becomes more difficult, it's going to be more difficult to roll over that debt. And as that debt becomes more difficult to roll over, it starts to produce a funding gap. And it produces wider credit spreads. Wider credit spreads in turn make the debt service payments more problematic. And that process begins. So I think that it is a development that is a factor which will happen. I think that in terms of changing the landscape, it's put France in the category of southern European countries.

But since that post, not much has happened. The French 10-year French bond yield rose 7 basis points to 2.39%, the 10-year French-German yield spread is unchanged at 48 basis points, the French 5Y CDS spread is still around 53 basis points (cost to insure French bonds), and the CAC 40 regained its recent losses.

10-Year French Government Bond Yield
Source: Investing.com (trend line added)

10-Year French-German Yield Spread (risk premium)
Source: CountryEconomy.com (trend line added)

It's not on the chart, but the CAC 40 made a lower high when it peaked in 2007. It hit a high of 6,945 in September 2000 and 6,164 in May 2007 (crazy retracement there). The CAC 40 recently retraced 50% of its losses from the 2007 high after breaking through resistance levels. Will it hit the 61.8% Fibonacci retracement level before it peaks? If it breaks through 4,075-4,100 support (the lowest highs during this cycle), it will be judgment day for the cyclical bull market. For confirmation of a reversal, the CAC 40 would need to break through its ascending channel/uptrend as well.

In the end, if volatility erupts in the French government bond market (interest rates rise), I don't see why it wouldn't spread to the French stock market and the rest of the Eurozone. But if the ECB was forced to print euros to save the Eurozone, French bonds and stocks would probably rise on the liquidity injections (money dilution). That seems to be how the system works these days.


CAC 40 Index
Source: TradingView.com

Source: TradingView.com

The euro is at an interesting inflection point (EURUSD).

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