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France 10-Year Bonds Yield 3.159%, Set to Lag Behind Bunds

French 10-year bonds yield 3.159%, 51 basis points higher than German notes, with spread potentially widening to 64 basis points.

By Max Weldon

6/10, 05:24 EDT

Key Takeaway

  • French 10-year bonds yield 3.159%, with spreads over German bunds expected to widen from 51 to 64 basis points due to political risk.
  • Snap French elections have already impacted global bond markets, adding risks alongside upcoming FOMC and BOJ meetings and the US inflation report.
  • Broader bond market vulnerabilities persist due to surprises in payroll growth, sticky inflation, and fiscal policy constraints, signaling potential advances for stocks and short-dated bonds.

French Bonds Under Pressure

France's longer-dated bonds are expected to underperform their German counterparts in the coming weeks. This shift comes as traders incorporate a political risk premium following the recent European parliamentary elections. French President Emmanuel Macron's defeat in these elections has led to a snap legislative ballot, introducing further uncertainty into the market.

Currently, France’s 10-year bonds yield 3.159%, which is about 51 basis points higher than comparable German notes. Analysts suggest that this spread could widen to 64 basis points, depending on the outcome of the two-phase polls. However, the spread is not expected to widen significantly beyond this level, as Macron's leadership itself is not directly at stake.

The carry and rolldown profile of the two securities also play a role in this dynamic. Holders of France’s 10-year debt face a negative carry but a positive roll, resulting in a net effect that is slightly more negative than 2 basis points per quarter. In contrast, German bunds have a cumulative effect of more than a negative 3 basis points. Despite this, the political risk premium is likely to overshadow the greater negative carry and roll on German bonds in the short term.

Market Reactions

The announcement of snap French elections has already impacted global bond markets. Early weakness in European bond futures has added to the risks posed by upcoming Federal Open Market Committee (FOMC) and Bank of Japan (BOJ) meetings, as well as the US inflation report. Initial moves in bond futures indicate a widening spread between German and French 10-year debt, which is expected to serve as a sentiment indicator for European risk assets.

Trading volumes have been modest so far, but a clearer picture will emerge once European cash markets open. Should OAT futures drop below the May nadir of 123.66, it would be broadly negative for G-10 bonds. This sentiment was echoed in the Markets Live Blog, which noted that the early moves in bond futures suggest a widening spread between German and French 10-year debt.

Broader Bond Market Vulnerabilities

The bond market rally appears vulnerable due to recent surprises in payroll growth and earnings. The frequency of large shocks in the monthly jobs data suggests that economists' forecasts are too clustered. According to Cameron Crise, rates are highly sensitive to such occurrences, making the bond market more volatile.

Fiscal policy also remains a critical factor. Regardless of who occupies the White House, the budget constraints suggest a period of austerity. With inflation remaining sticky, a low jobless rate, and strong payrolls undercutting hopes for easing, the US economy resembles the 1990s era of small and cautious cuts. This scenario signals potential advances for stocks, cash, and short-dated bonds in the face of a resilient US economy.