French Bond Yields Surge, Euro Dips on Macron Election Move

Key Takeaway

• French 10-year bond yields surged by 13 basis points, with the spread over German bonds widening to 56 basis points due to Macron's snap election call.
• The euro fell by 0.2%, nearing a one-month low, while European stocks also declined amid political uncertainty in France.
• S&P downgraded France's credit rating to AA-, citing fiscal challenges; government debt is projected to rise to 112% of GDP within three years.

French Bond Yields Surge

The spread between French and German bond yields has reached its highest level since October, driven by recent political developments in France. French President Emmanuel Macron's unexpected call for a snap parliamentary election on Monday has unsettled investors, leading to a significant sell-off in French government bonds. The yield on 10-year French OATs (Obligations Assimilables du Trésor) climbed by 13 basis points on Monday, while the spread over comparable German securities widened by 8 basis points to approximately 56 basis points.

The market reaction reflects heightened political uncertainty, with investors wary of the potential outcomes of the upcoming two-phase elections, which conclude on July 7. The spread between French and German bond yields could widen further, potentially reaching 64 basis points. Ven Ram, a Bloomberg analyst, noted, "The selling in French bonds is far from done," indicating that the market has not yet fully priced in the risks associated with Macron's announcement.

Euro and Market Reactions

The euro has also been affected by the political turmoil, declining by 0.2% and nearing Monday's one-month low of $1.0733. European stocks traded near the day's lows, reflecting broader market concerns. The uncertainty surrounding France's political landscape has added to existing investor apprehensions about the country's growing debt levels.

In contrast, UK gilts have outperformed, supported by 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 European markets.

Fiscal Concerns

The political uncertainty in France is compounded by 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 gross domestic product (GDP) last year, up from 4.8% in 2022. S&P projected that government debt would increase to 112% of GDP within three years, up from about 109% last year.

Ven Ram's OAT model, which has a strong explanatory power for 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 "France’s bonds are far from fully incorporating the fallout from Macron’s dramatic announcement," suggesting that further adjustments may be necessary as the political and fiscal landscape evolves.