France’s minority government faces a challenge as Prime Minister François Bayrou announced a September 8 confidence vote on his €44 billion budget-cutting plan. The National Rally, Greens, and Socialists plan to oppose it, increasing the likelihood of the government’s collapse.
If Bayrou loses the vote, his cabinet will fall, requiring President Emmanuel Macron to either appoint a new prime minister, keep Bayrou as caretaker, or call for new elections. Political instability has already affected markets: French bond spreads over German Bunds increased by 5 basis points, the highest since mid-June, and the CAC 40 index fell by 1.6%.
Previous Prime Minister Loss
Macron has previously lost a prime minister over a budget no-confidence vote, emphasising the administration’s instability. Bayrou acknowledged the risk of this move but believes that not addressing France’s 5.8% GDP debt burden, almost double EU limits, poses a greater risk. Even if Bayrou survives the vote in September, it does not ensure the budget will pass another vote later in the year.
With the confidence vote scheduled for September 8, we should expect market volatility to increase significantly in the coming two weeks. The price of options on the CAC 40 index will likely rise as investors brace for bigger price swings. This makes buying options a direct way to trade the expected uncertainty.
Given the high chance of the government falling, we should consider buying put options on the CAC 40 to profit from or hedge against a market decline. We saw a similar situation back in June 2024 when the snap election announcement caused the index to drop over 6% in a single week. A repeat of that kind of downward move is very possible if the government loses the vote.
For a more defined strategy, traders could use bear put spreads on the CAC 40. This involves buying a put option and selling another at a lower strike price, which lowers the upfront cost of the trade. It is an effective way to bet on a drop in the market while capping both risk and potential reward.
Widening French German Bond Spreads
The widening spread between French and German bonds is another key area to watch. As this spread, a core measure of risk, pushes towards the 80 basis point highs we saw during the 2024 election scare, traders can short French OAT futures against long positions in German Bund futures. This trade profits directly if investors continue to demand a higher premium for holding French debt.
However, we must also consider the possibility that the government survives the vote, which would trigger a sharp relief rally. In that scenario, the high implied volatility currently priced into options would collapse, causing their value to drop fast. Selling options to collect these rich premiums is a viable, though riskier, strategy for those who believe the government will pull through.
