French 10-Year Yield Spread Peaks, S&P Downgrades to AA-

Key Takeaway

• French 10-year OAT yields rose by 7 basis points, widening the spread with German bonds to its highest since October.
• Political uncertainty from Macron's snap parliamentary elections and fiscal concerns are driving market reactions.
• S&P downgraded France's credit rating to AA-, citing a budget deficit increase to 5.5% of GDP, impacting investor sentiment.

French Bond Yields Rise

French government bonds experienced a notable decline as political uncertainty following the European Parliament elections continues to weigh on investor sentiment. The yield on 10-year French OATs (Obligations Assimilables du Trésor) rose by 7 basis points, pushing the spread with German bonds to its highest level since October. This increase in yields reflects the market's reaction to the unexpected political developments in France.

The euro also saw a decline, dropping 0.2% and nearing its one-month low of $1.0733. The political landscape in France has been turbulent since President Emmanuel Macron called for snap parliamentary elections, a move that caught many investors off guard. The elections, set to conclude on July 7, have introduced a significant degree of uncertainty, which is likely to persist over the coming weeks.

Market Reactions and Projections

The market's response to Macron's announcement was swift, with the yield on 10-year OATs climbing 13 basis points on Monday. The spread over comparable German securities widened by 8 basis points to approximately 56 basis points. Analysts suggest that this spread could widen further to 64 basis points, especially if the elections result in a victory for Marine Le Pen’s National Rally, reminiscent of the market conditions seen during the 2017 French presidential election.

Ven Ram, a Bloomberg analyst, noted, "Despite the selling that we saw on Monday, France’s bonds are far from fully incorporating the fallout from Macron’s dramatic announcement." He added that his OAT model, which closely tracks the movements in French securities, indicates that the fair value of the 10-year maturity is 3.194%, while the current trading value is 3.224%, suggesting only a marginal discount.

Fiscal Concerns and Credit Rating

Adding to the political uncertainty, France's fiscal health has also come under scrutiny. Less than two weeks ago, S&P Global Ratings downgraded France's credit rating from AA to AA-, citing the government's failure to contain the budget deficit. The deficit widened to 5.5% of GDP last year from 4.8% in 2022. S&P projects that government debt will increase to 112% of GDP within three years, up from about 109% last year.

This combination of political risk and fiscal challenges is likely to continue affecting French bonds. Mark Cranfield, another Bloomberg analyst, concurs with this assessment, highlighting that the lack of fiscal discipline and political instability may further pressure French debt securities.