Last month, French politics was thrust into a fresh crisis following Prime Minister Francois Bayrou's surprise move to seek a confidence vote on September 8 on his widely unpopular debt-reduction plan.
Should Bayrou's gamble fail, French President Emmanuel Macron may decide to dissolve parliament and either conduct new parliamentary elections or put a new government in place. Macron could also choose to name a new prime minister, Reuters reported, citing an unnamed government source.
In any event, analysts at Capital Economics expressed doubts that the vote will help resolve a French budget deficit that remains "well above the level needed to stabilize" the country's debt ratio.
France's government has set ambitious deficit reduction targets, looking to bring the shortfall down from 4.6% of gross domestic product next year to 2.8% by 2029. In order to meet these goals, a combination of spending cuts and other structural reforms have been proposed that are altogether worth 43.8 billion euros.
But the viability of the plan is a cause of deep uncertainty, as several sections -- including the proposed abolition of public holidays -- have drawn fierce resistance from voters.
All of this is coming as a draft budget must be submitted by October 7, before being split into two components that must be separately approved within 70 days.
French financial markets sold off following Bayrou's call for a confidence vote, with opposition parties saying they would reject his proposal and take advantage of the chance to oust his minority government from power.
"The initial market reaction was swift but orderly: credit spreads widened modestly, and CAC40/policy-sensitive French equities declined," analysts at UBS said in a note. "Since then, the French risk premium has persisted but remained contained."
They added that they believe investors have largely absorbed the political shock associated with the upcoming vote, although "valuations could shift materially depending on the outcome."
Against this backdrop, the strategists led by Julien Conzano recommended that investors short 10-year French government bonds versus euro swaps, arguing that "peak uncertainty is likely to materialize around September 8."
Profit-taking on French banking stocks is warranted as well, they said, adding that once the murky outlook passes "we would look to reverse the position and re-engage selectively to capture the embedded French risk premium."
Finally, they backed selling puts on the Europe-wide Stoxx banking index to "earn premium income given limited earnings risks and global exposure."