France: A two-speed year

The French National Assembly adopted the 2026 Budget on 2 February. This marked the end of a long period of political uncertainty that has led to the fall of two governments (Bayrou and Lecornu I) since mid-2025.The Budget's adoption reduces short-term political risk and confirms the continued fiscal consolidation, with the government’s public deficit target of 5.0% in 2026. We consider this target reachable. In the meantime, French GDP growth has proven resilient so far and we expect GDP growth above 1% in 2026.Although most indicators are turning “green” for the first half of the year, we identify several risks for second half with the preparation of the 2027 budget and the start of the Presidential campaign. Should these risks materialize:►   On the rates side, we stick to the “political stability factor" as the primary driver over fundamental public finance ratios and we think H1 2026 is a good opportunity in terms of carry window. From H2 onwards, we will lower OAT risk in portfolios with an OAT-Bund 10Y spread target to 75bp by end of year.►   We expect some relief for French banks' credit performance over the next 3 to 6 months, driven by a more stable political environment as well as rock-solid credit fundamentals. We believe this positive spread performance will reverse around 4Q26, which would then require a more defensive positioning of portfolios.►   If the sensitivity is broadly consistent with June 2024 and August 2025 and OAT-Bund spread reaches a peak of 80bp, we expect a possible widening of French covered bond spreads vs swap by May 2027 up to 5 bps on average, albeit to a lesser extent than that of the OAT-Bund spread.