French politics inject uncertainty, but spread widening remains more confined to French bonds for now
Eurozone spreads appear increasingly volatile, with French bond yields continuing to widen following reports that a confidence vote is being scheduled for two weeks from now. The French government's struggle to pass its budget is not entirely surprising, but it is all coming to a head a little sooner than expected
The 10y spread of French over German bonds briefly traded around 79bp before recovering somewhat. The 10y benchmark spread saw similar levels in April after 'Liberation Day', but 80bp also roughly marks the upper end of the spread since the last legislative elections were called in June 2024. Spreads briefly topped that level when the Barnier government’s budget proposals were rejected and the government was ousted in a no-confidence vote in December 2024. Subsequently, we saw some retightening of spreads as the Bayrou government was formed and survived confidence votes in January.
One difference this time is that new legislative elections are possible, as the mandated one year has now passed since the 2024 elections. With hopes dashed that the Bayrou government will manage to muddle through on the budget, this adds to the political stakes this time around.
For a broader context, there has been some general widening of eurozone bond spreads already since mid-August. But we would blame this in part to investors waking up again to the resuming issuance activity after the summer break – and of course a European Central Bank that is no longer as supportive, having signalled that the easing cycle is coming to an end.
While that sets the scene for modest rewidening pressures, the latest spread moves on the back of French political turmoil still point to some containment of the issue within French bonds. While countries such as Belgium and Austria are increasingly drawing scrutiny from rating agencies over budgetary concerns, this is being offset by more positive sentiment in nations like Italy and Spain, where recent rating upgrades and improved outlooks have bolstered investor confidence.
US long-end under pressure as Fed independence is on the line
In the case of a challenge to the Fed’s independence, the spillovers to other rates markets could be less. Typically, sharp rises in 30Y US rates have material spillovers to euro rates, as they are related to common drivers. For instance, the recent global upward trend in 30Y bond yields can be mostly attributed to supply pressures. We have central banks unwinding their bond portfolios as part of quantitative tightening, whilst governments all over the world are pushing their fiscal limits.
Central bank independence is more country-specific, whereby bond investors increase inflation expectations and seek a higher term risk premium to compensate for volatility. Due to the idiosyncratic nature, this impact doesn’t have to exhibit the same spillovers as seen with the supply factors. On the contrary, other bond markets may benefit since investors seek alternatives. As such, a further rise in the back end of the US curve does not necessarily translate to higher yields for eurozone bonds.
Wednesday's events and market view
A very light day in terms of data, with the weekly US MBA mortgage applications data being the highlight.
For supply, the UK will auction £5bn of 3Y gilts and Germany will auction a 7Y Bund for €4bn. From the US, we have a 2Y FRN auction totalling $28bn and a 5Y Note auction at $70bn.
