French government bonds have fallen to become "subordinate" European sovereign debt.

Zhitong Finance ·  Jun 12 17:25

The hierarchical structure of Europe's sovereign debt market is being reordered.

The hierarchical structure of the European sovereign debt market is being reordered, and France's increased political risk has placed the country's bonds at the same level as other sovereign bonds with lower credit ratings. French bonds are one of the most liquid bonds in the European market and are traditionally seen as an alternative to Germany's most secure assets. But now the situation is different. Since French President Emmanuel Macron announced early parliamentary elections on Sunday, French bonds have experienced a sharp sell-off. The yield on some bonds now exceeds that of Portuguese bonds, and is only a few basis points lower than Spanish bonds.

For veterans of the European bond market, the Eurozone's second-largest economy and market heavyweight bonds are now on par with the bonds of lower-rated economies. This is a matter of concern. The debt levels of these lower-rated economies are so high that they once threatened to drag down the Eurozone. At the height of the crisis more than a decade ago, the yield on Portuguese 10-year treasury bonds was about 14 percentage points higher than French treasury bonds.

Jan von Gerich, chief analyst at Nordic Union Bank, said: “This is a useful reminder that the political and fiscal outlook remains important. In the Eurobond market, political risk seems almost forgotten.”

To a certain extent, repricing explains the excellent performance of European peripheral countries in recent years. These countries have reduced their debt burdens and reformed their rigid economies, making their own economies one of the fastest-growing countries in the Eurozone. It also reminds investors that even today, advanced economies cannot escape strict market scrutiny.

On Tuesday, there were reports that Macron was preparing to resign, and the sell-off intensified further. Although this claim was quickly denied, the sell-off spread to other markets, and Italy's yield premium on German treasury bonds rose 11 basis points at one point. French bonds rose slightly in early Wednesday trading, ending four consecutive days of decline.

Investors sell French bonds as political risks raise concerns

Earlier, France's far-right National Union won the European Parliament election and won more than 30% of the vote, far surpassing the Baath Party led by French President Emmanuel Macron by less than 15%. Macron immediately announced the early dissolution of parliament for elections, hoping to prevent the extreme right from coming to power; and hold new National Assembly elections. Macron's strategy has upset investors, who are now questioning the already strained public finances and the future of his pro-business agenda.

The vote scheduled for later this month could be the final showdown on Macron's iconic economic policies, which have largely appeased investors and businesses since taking office in 2017. Although Macron's administration has spent significant amounts of money to protect households and businesses from the COVID-19 pandemic and the energy transition, the president has focused on long-term savings and growth-friendly reforms to pension, labor laws, and welfare systems. During Macron's administration, France's unemployment rate declined markedly, and economic growth was more resilient to the crisis than other European countries.

His approach has faced growing resistance in both Parliament and popular protests. After losing an absolute majority in the National Assembly in 2022, Macron is already trying to get legislation passed in parliament without resorting to constitutional tools to bypass voting. Macron's attempt to block rival Le Pen's path to power by holding early elections made investors uneasy and raised further questions about the already tight public finances and the future of his pro-business agenda.

If Macron's ruling party loses control of parliament and government, efforts to fill the budget gap will become more difficult. Due to fiscal deficit issues, S&P Global Ratings downgraded France's sovereign credit rating last month, indicating that the government deficit will remain above 3% of GDP until 2027. According to France's fiscal supervisory authority, the government's deficit strategy lacks coherence and credibility. The International Monetary Fund, on the other hand, called for additional “substantial” efforts. Deutsche Bank, on the other hand, said that the risk is that the government is unlikely to comply with EU regulations to control deficits, and pointed out that the National Union is showing strong performance.

Meanwhile, according to European Commission forecasts, Portugal has made great strides in reducing its debt as a share of GDP, which is expected to drop further to 91.5% by 2025. By contrast, France's debt-to-GDP ratio is expected to rise from 112.4% in 2024 to 113.8% next year.

On Tuesday, the yield difference between French 10-year treasury bonds and Spanish 10-year treasury bonds narrowed to the lowest level since the financial crisis. Compared to Portugal, some French bonds are already yielding higher. For example, the yield on Portuguese treasury bonds due 2032 was 3.04% on Wednesday, while the yield on French treasury bonds of roughly the same period was 3.09%.

Daniel Loughney, head of the fixed income department at Mediolanum International Funds Ltd., said: “As far as the political environment is concerned, there is some potential uncertainty about whether this is the new normal.” However, he said, the “impact on other countries, particularly Italy, which benefit from a more stable political context” is currently unclear.

The translation is provided by third-party software.

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