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Europe’s second largest economy has multiple fronts. The economy is stuck, as seen in consumer spending. It’s perfect AAA status is all but gone. This immediately risks the AAA status of the EFSF bailout fund.

In addition, France holds presidential elections in April. Expectations are for an ousting of incumbent Nicolas Sarkozy by socialist Francois Hollande.
This analysis originally appeared in the Forex Outlook for Q1 2012. You can download the full report for free by joining the mailing list in the form below.

French risks:

  1. Credit downgrade: The downgrade of France is long awaited, and it certainly hurt the euro, even though it was only a one notch downgrade. There are two more large rating agencies and every announcement will hurt. A “sell the rumor, buy the fact” reaction isn’t likely.
  2. Big Banks: The worst issue is the bloated banking system. Dexia was only partially French, but the big French banks have a high exposure to peripheral debt and are over leveraged. The LTRO operation certainly eased some pressure, but wasn’t enough. A downgrade of the sovereign is usually followed by a downgrade of the banks and this will add to pressure. There were already rumors of failures of different French banks. This could certainly happen in Q1, with the French government providing aid. This in turn, will weigh on the rating of the government, and also on the economy.
  3. Recession: Figures released during Q1 will show if France contracted in Q4 2011. Chances are high and even higher for contraction in Q1 2012.

All these things together, can break the Paris-Berlin bond that is the core of the euro-zone. The shockwaves will have a strong and negative impact on the euro. It’s hard to see anything positive coming out of France during Q1 2012. Each scenario is negative. Any news coming out of France seems to be bad news.

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