While the main political headache in the US is the inability — or rather, unwillingness — of Democrats and Republicans to reach a budget agreement, which has led to another government shutdown, Europe's biggest concern remains France, where another prime minister has resigned, less than a month after taking office.
Markets reacted to the blow accordingly, with the euro falling against the dollar, along with France's CAC 40 index and the Euro Stoxx 50, while French and German government bond yields rose. On the other hand, gold (XAUUSD), the traditional safe haven, experienced another upward surge, approaching the $4,000 mark.
Why don't French prime ministers last in office?
To understand the magnitude of the problem, the country has just lost its fifth prime minister in just two years. So while Monday's resignation was not exactly surprising, it reinforced the sense of prolonged political instability, which does nothing to reassure investors, especially those holding French sovereign debt.
At the heart of the problem lies the government's inability to address France's fiscal imbalance. The budget deficit currently stands at around 6% of GDP, double the 3% limit set by the EU. Public debt has risen to approximately 114% of GDP, well above the threshold recommended by the EU.
It's not that there are no ideas for solving the problem. The solution is straightforward: raise taxes and cut spending. That is precisely what François Bayrou's initiative proposed, aiming to drastically reduce the deficit from 5.8% in 2024 to less than 4.6%. However, it ended up facing a vote of no confidence.
In addition to the obstacles posed by opposition parties, all reform efforts to cut budgetary spending face fierce resistance from public opinion. The fundamental question, then, is how to cut spending or raise taxes enough to balance the budget without triggering another social crisis that could hit the country's growth.
Is the euro in danger?
In theory, if the stalemate continues, not only could rating agencies further downgrade France's credit rating, which would further increase financing costs, but the crisis could end up spreading to the bloc's financial sector, causing capital outflows, higher inflation, a weaker euro, judging by the EURUSD chart, and a fall across the EU markets.
However, much will also depend on what happens with the US dollar, and the outlook for now is not very promising. In addition to the government shutdown and expectations that the Fed will continue to lower interest rates, US debt and persistent trade tensions could continue to weigh on the dollar in the long term.
