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French political turmoil clouds Moody's ratings review

French fear Frexit behind Brexit

Heightened French political risk and policy uncertainty, reflected by a jump in sovereign yields and a weaker single currency, are clouding a scheduled ratings review by Moody's, economists and currency strategists told CNBC.

Moody's rates French government debt at Aa2, the third-highest investment grade ranking, but some are not ruling out a cut in the outlook to negative from stable. Others, however, said they believe such action is unlikely until after the conclusion of the French presidential elections and a clarification about the winner's economic platform and commitment to the European Union.

"The experience from similar episodes is that a country will be put on a negative outlook, but not downgraded until the worst is confirmed," said Benat Onatibia, macro strategist at Vanda Securities. "That's what happened with DBRS on the Italian referendum. Hence, we see it as highly unlikely, especially given how low Le Pen's victory odds are."

Though trailing in the polls, far-right leader Marine Le Pen's call to take France out of the European Union is rattling financial markets, pushing the premium investors demand to hold French debt over German bonds to its highest since 2012.

French National Front political party leader Marine Le Pen arrives at the Elysee Palace in Paris, France, to attend a meeting with government, main political parties leaders and presidents of the Parliament, November 15, 2015.
Philippe Wojazer | Reuters

"The widening of this yield premium is a classic sign of increasing investor risk for France," said Heng Koon How, senior FX strategist at Credit Suisse. "We have long argued that markets are complacent about increasing political risk in Europe."

Cutting the outlook on French debt would "be a bit premature," Heng said, though Le Pen's publication of a 144-point manifesto to take France out of the Eurozone is contributing to elevated stress in the French debt, he said: "That worried investors."

Moody's last month warned of the rise of populist parties fielding candidates in 2017 elections and the impact on the future of the European Union.

"While it is unusual for changes in government to have material credit implications, the far-reaching nature and ubiquity of the political shifts under way means that the impact of the upcoming elections could be more significant from a credit perspective than is usually the case," Moody's said in its outlook on January 12.

Macquarie's FX strategy team said the expected Moody's ratings review was a "scheduled exercise" and didn't necessarily imply any action, "but should be worth monitoring given how French yields have been rising in recent sessions."

Olivier Desbarres, independent G10 FX strategist suggested Moody's may even take action before the presidential polls conclude.

"Rating agencies want to come across as apolitical so if they think that a downgrade is justified they may not wait until after elections," Desbarres said. "The recent rise in French yields, although modest, could at the margin be stretching debt dynamics."

"Moreover, if the new president loosens fiscal policy, which most presidential candidates clearly want to do (with the exception of Fillon), that in itself could put France's credit ratings under pressure," he added.

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