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Risk Is Back—French Downgrade Can't Dent Sentiment

Financial markets are back in risk mode amid optimism that a deal will be done to avert a U.S. "fiscal cliff" of looming tax hikes and spending cuts. Even news of France being stripped of its much-coveted triple-A credit rating is unlikely to put a dent in stock market gains, analysts told CNBC.

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Ratings agency Moody's Investors Service lowered France's debt rating by one notch to Aa1 early on Tuesday, highlighting weakness in Europe's No. 2 economy.

(Read More:France Is Dealt Another Downgrade — Who Is Next?)

Analysts said there are two reasons why this is likely to be just a temporary setback for risk appetite. The first is that the downgrade brings Moody's ratings for France in line with a move earlier this year by rival agency Standard & Poor's, so the negative news has already been priced into markets.

The second, and perhaps bigger reason, is that the main focus for markets right now is the U.S. "fiscal cliff." And positive signs that politicians are willing to reach a deal to avoid the $600 billion in tax increases and spending cuts due at the start of 2013 is helping risk appetite bounce back from the jitters that hit global markets after the U.S. election on November 6.

"I think a lot of the bad news has already been priced in. I'm a little bit more upbeat in the scheme of things, I think we're going to see the "fiscal cliff" unwind," Paul Bloxham, chief economist for Australia and New Zealand at HSBC told CNBC Asia's "Squawk Box".

The U.S. and European stock markets on Monday logged their best one-day rally since September, with the S&P 500 index closing 2 percent higher, sharply up from three-month lows hit on Friday. In Asia, the MSCI index of Asian shares, excluding Japan, is up 1.25 percent from Friday's two–month trough.

David Poh, regional head of asset management at Societe Generale in Singapore, said he was more positive now regarding the "fiscal cliff."

"Looking at what President (Barack) Obama has said about ensuring a compromise and a deal, we are a bit more positive compared with two to three months ago," he told CNBC, adding that "If you look at history, there was talk about a "fiscal cliff" in August 2011 and U.S. stock markets fell about 16 percent in the space of one to two weeks. It's been a case of déjà vu in the past week, with markets falling about 9 percent."

Obama met with Congressional leaders on Friday with both voicing optimism about resolving the "fiscal cliff."

Certainty and Uncertainty

Positive comments on finding a solution to the "fiscal cliff" and the unveiling of China's new leadership team have removed two big uncertainties hanging over investors, said Timothy Riddell, head of global markets research at ANZ, adding that this was the key to the 'risk on' mode in markets.

"It's all about certainty and uncertainty," he said. "We're seeing the withdrawal of uncertainty and risk scenarios in the U.S. and China – in Asia, there is a sense of comfort that in China the new leadership is in place, although it will take some time before we see any policy changes there."

(Read more: Changing China: The New Leaders)

Analysts, however, said worries about the euro zone debt crisis remained a concern. At the same time, resurgence in Japanese stocks was adding to the overall positive sentiment globally, they added.

Japan's benchmark Nikkei 225 stock index has gained 6 percent in the space of a week, hitting a two-month high on Tuesday. Expectations that Japan's opposition Liberal Democratic Party (LDP), which favors unlimited monetary easing, will come to power after elections next month has boosted Japanese shares.

"There are lots of expectations that a new government led by the LDP will make market-friendly policy appointments. For global risk appetite, that is encouraging," said ANZ's Riddell.

- By CNBC's Dhara Ranasinghe; Follow her on Twitter: @DharaCNBC

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