France Near to Finalising 2026 Budget
France appears near to finalising a 2026 budget after lengthy negotiations, with fiscal challenges persisting as the deficit remains at 5% of GDP. The government’s efforts are sufficient to prevent a crisis, maintaining a stable status with no major resolutions or downward spirals expected until the 2027 elections.
Eurozone inflation is stable, close to the European Central Bank’s 2% target. Whilst overall inflation remains consistent, there are variations within member countries. For instance, French and Italian inflation is below target, contrasting with Germany and the Netherlands. With core inflation set to remain stable, the ECB is likely to maintain current interest rates.
Given that the European Central Bank is expected to remain on hold, we should anticipate continued low volatility in interest rate markets. The latest flash estimate for January inflation came in at 1.8%, reinforcing the view that there is no urgency for the ECB to move rates in either direction. This environment is favorable for strategies that profit from range-bound prices, such as selling short-dated options on EURIBOR futures to collect premium.
Optimistic Stance on European Equities
The fragile but ongoing recovery suggests a cautiously optimistic stance on European equities. With the VSTOXX volatility index recently hitting a 12-month low of 14.5, outright long positions might not offer the best risk-reward, but bull call spreads on indices like the Euro Stoxx 50 could capture modest upside. This approach allows us to participate in the recovery while defining our maximum risk.
In France, the likely passage of the 2026 budget has removed a significant near-term risk, which should benefit French government debt relative to its German counterpart. We have already seen the spread between French and German 10-year bonds tighten to 45 basis points this month. A long position in OAT futures against a short position in German Bund futures remains an attractive trade to capitalize on this reduced political uncertainty.
We see the turnaround in manufacturing throughout 2025 as a solid foundation for corporate earnings, especially with the recovery in domestic demand. Full-year data from last year showed European car sales rising 6.7%, confirming the strength in consumer spending mentioned in the report. This underlying strength supports targeted bullish plays, potentially through call options on European automotive or industrial sector ETFs.
