Bond Market Slaps France

Moody's warns on French rating outlook
(Reuters) - Moody's warned France on Monday that a sustained rise in its debt yields coupled with weakening economic growth could harm its ratings outlook, fuelling concern the euro zone's second largest economy might lose its coveted AAA status.
 Worries about a high fiscal deficit and banks' exposure to other troubled European sovereign debt have drawn France into the firing line of the bloc's escalating crisis, despite the government's insistence it would do everything necessary to protect its top rating.
 Moody's announced in mid-October it could place France's AAA rating on negative outlook in three months if the costs for helping to bailout French banks and other euro zone members overstretched its budget.
On Monday, the rating agency said that a worsening in the French bond market -- amid fears the sovereign debt crisis was spreading to the euro zone's core -- posed a threat to its credit outlook, though not at this stage to its actual rating.
"Elevated borrowing costs persisting for an extended period would amplify the fiscal challenges the French government faces amid a deteriorating growth outlook, with negative credit implications," Senior Credit Officer Alexander Kockerbeck said in Moody's Weekly Credit Outlook dated November 21.
 The premium investors charge on French 10-year debt compared to the German equivalent was up around 20 basis points at 163 bps following publication of Moody's report but remained well short of the 202 bps hit last week, a new euro-era high.
          CAUGHT IN A TRAP
Finance Minister Francois Baroin said that, despite a recent increase in the spread of French yields over benchmark German debt, France continued to finance itself in the market at "very favorable" levels and modest austerity measures announced last month would not harm economic growth. France's average medium- and long-term financing for the first 11 months of the year stood at 2.78 percent, its second lowest level since the creation of the euro, after hitting 2.53 percent in 2010, national debt agency AFT told Reuters.
Economists, however, said that France risked being sucked into a "fiscal trap" where slowing growth necessitated more austerity measures, which in turn slowed growth even further. "If on top of that you have interest rates which are increasing it means you have a vicious cycle where it's almost impossible to stabilize the trajectory of the debt and that could add pressure on the ratings," said Olivier Bizimana of Morgan Stanley, noting it appeared likely Moody's would revise down France's stable outlook if nothing changed. France's government recently cut its growth forecast for next year to 1 percent, from 1.75 percent, but most private economists still consider that far too optimistic.
My View: 

 The bond market, spooked by events in Greece and Italy, is turning its attention to France.

 High sovereign debt levels and a low to no growth environment mean deficits will quickly balloon the debt further.

 France has a debt to GDP level of 85% with annual deficits running in the 5 to 6% range.

 As France is already past the 80% debt to GDP level of no return, we can expect deficits to continue to accelerate unless harsh austerity is enforced.

 Even with a balanced budget (if that was politically possible with austerity), the debt level is now so high, that the French economy is vulnerable to exogenous shocks.

 Further, with deficits near 5% and GDP growth at 1%, the real economy is in fact shrinking at the rate of 4% annually.

 Like other indebted western democracies, there is only once way out for France, to default on the debt.