French 10-Year Yield Spread Widens Amid Political Uncertainties

Key Takeaway

• French 10-year bond yields rose by 7 basis points to 3.27%, widening the spread over German bonds to 63 basis points.
• Political uncertainty from Macron's snap election call and fiscal challenges, including a credit rating downgrade, are impacting investor confidence.
• Broader market reactions include a 0.2% drop in the euro, declines in European stocks and US equity futures, and a rise in Treasuries ahead of US CPI data.

French Bond Yields Rise

French government bonds experienced a notable decline as political uncertainty following the European Parliament elections continues to impact investor confidence. The yield on 10-year French securities increased by 7 basis points, reaching 3.27%. This rise has widened the spread over equivalent German bonds to 63 basis points, the highest level since October. The market reaction is largely attributed to President Emmanuel Macron's unexpected decision to call a snap parliamentary election, which has introduced significant uncertainty regarding the future of his economic policies.

The spread between French and German bonds had already widened by 8 basis points on Monday, following Macron's announcement. Analysts suggest that the spread could potentially widen further to 64 basis points, especially if the election results favor the far-right National Rally led by Marine Le Pen. This scenario could mirror the market conditions seen during the run-up to the French presidential election in 2017.

Market Reactions

The broader market has also reacted to the political developments in France. The euro fell by 0.2%, nearing its one-month low at $1.0733. European stocks declined for the third consecutive day, with miners leading the losses as copper prices dropped. US equity futures also saw a decline, while Treasuries climbed ahead of the upcoming US CPI and Federal Reserve announcements. The Bloomberg Dollar Spot Index rose by 0.2%, and oil prices saw a slight decrease, with WTI falling by 0.3% to trade near $77.50. Spot gold also declined by approximately $7, trading around $2,304 per ounce.

The UK market showed a different trend, with gilts outperforming due to an unexpected rise in the UK unemployment rate and record orders for a 10-year bond sale. This divergence highlights the varying impacts of political and economic developments across different regions.

Fiscal Concerns

In addition to political risks, France is also grappling with fiscal challenges. 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, up 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.

Ven Ram, a Bloomberg analyst, noted that despite the recent sell-off, French bonds have not fully priced in the negative factors surrounding them. His OAT model, which explains the movements in French securities, suggests that the fair value of the 10-year maturity is 3.194%. Currently, the security is trading at 3.224%, indicating a marginal discount of three basis points. Ram emphasized that the combination of political risk and fiscal challenges could continue to affect French bonds.