The Trouble With France

Paris France Louvre
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The euro zone has been a little reminiscent of Charles Dickens' "Tale of Two Cities" lately, with the best of times in the north and the worst of times in the southern peripheral countries.

These days, though, the neat literary analogy is making a little less sense, according to Marc Chandler, chief currency strategist at Brown Brothers Harriman. "What seems to have been a free ride for France may be coming to an end," he wrote in a note to clients.

The trouble with France, Chandler says, is that they keep falling short in key economic reports. The German economy appears to have turned a corner, he says, but "French data continues to disappoint."

French President Francois Hollande's long-time economic growth projection has been well above consensus, and if growth doesn't reach those levels, France will be at serious risk of running a budget deficit in excess of the three percent standard for euro zone countries. Sure enough, the prime minister on Wednesday indicated that France will, in fact, miss the deficit target - hardly good news for the country or, by extension, for the euro.

(Read more: CNBC: Political Risks to Watch in France)

Joerg Asmussen, a German member of the European Central Bank board, has already spoken out about France's troubles, saying that France and Germany have a special obligation to meet the target.

Hollande's options for getting to a three percent deficit are limited if growth falls short. He may have to pare back future public pension benefits, at his own political peril.

So far, investors don't seem overly worried, Chandler says. At the moment, French and Germany two-year and ten-year bond yields are almost perfectly correlated. Also, French two-year bond yields are inversely correlated with yields on bonds issued by both Spain and Italy. But the correlation between 10-year yields has moved from an inverse relationship to zero.

"Investors who share our misgivings about France should continue to monitor these correlations," Chandler says. If the relationships break down, it "would suggest a new phase of euro area tension is at hand."

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