French Government Bonds Suffering From Investor Negativity
As last week drew to a close on Friday, 24th October, financial markets witnessed historic turbulence in French government bonds, with concerns regarding public debt and severe political unrest acting as the main culprits. Experts note that investors have growing doubts about the future of the French economy – citing a massive debt burden, sluggish growth, and demonstrations spilling over into the streets. Holders of 10-year bonds are now demanding a premium to hold French sovereign debt, with yields rising by as much as 13 basis points to 5.14%. Concurrently, the premium of French 10-year bonds over German Bunds widened by 19 basis points, driving the spread to 1.78 percentage points. The last time markets witnessed a spread of this magnitude was in 2011, when the Eurozone Debt Crisis* reached its zenith.
* Eurozone Debt Crisis – Reached a critical existential boiling point, morphing from an isolated, localised issue in Greece into a systemic threat that brought the single currency area to the brink of collapse. Contagion spread rapidly from smaller economies to larger ones such as Italy, Spain, and Portugal. Greece and Ireland both required bailouts in 2010, followed by Portugal in 2011.
The problem was that domestic banks held massive amounts of government debt, and as bond values rapidly headed south, banks neared insolvency, requiring government bailouts that plunged them deeper into debt. Furthermore, eurozone countries were trapped inside a shared single currency, and the heavily indebted nations (like Greece and Italy) could not artificially lower currency values to stimulate trade and export growth.
In the end, the European Central Bank (ECB) stepped in late December 2011 by deploying its Long-Term Refinancing Operation (LTRO), pumping circa EUR 490 Billion in ultra-cheap three-year loans directly into commercial banks, staving off what would have been a nightmare credit freeze. Ultimately, in 2012 ECB President Mario Draghi (in office 2011 – 2019) pledged “Whatever It Takes”, which finally turned the tide.
Experts suggest that France is facing one of its worst political and fiscal crises in recent memory, with the consequences reverberating through its government bond market. Indeed, rioting and protests throughout the country are the backlash against government austerity programmes putting on pressure to reduce the government deficit. The government hopes to bring the deficit down from 5.40% of GDP to 5.00% through 2027 via an EUR 54 Billion fiscal adjustment package. However, analysts advise that public debt is expected to breach 120% of GDP*, whilst annual interest payments are expected to hit circa EUR 92 Billion up from a previous estimate of circa EUR 79.20 Billion.
* EU Fiscal Rules – European Union fiscal rules dictate that member states must keep annual budget deficits below 3.00% of GDP and total public debt below 60.00% of GDP.
Even before the protests began, the French sovereign bond markets were already under pressure rattled by months of political and fiscal uncertainty. On Monday 19th October, the yields on government bonds were already rising with the 10-year already up by 8 basis points to 4.86%, the 2-year yield rising to 3.64%, and the 30-year yield climbing to 5.40%. The French government bond market is making life difficult for the ECB because as the spread between French and German government bonds widens, the ECB is tasked on the one hand to prevent sovereign stress from accelerating whilst also tasked with taming inflation.
Analysts confirm that France has one of the highest deficit-to-GDP ratios within the eurozone and furthermore advise that the economy has literally slowed to a crawl – with the growth forecast for year-end 2026 being cut by the government to 0.50%. Financial markets feel that if borrowing costs stay high, then refinancing costs will be at a higher rate incurring heavier debt. Some political commentators think that French politicians will, given the current protests shy away from putting France on a sustainable debt reduction path, which according to analysts, may well increase sovereign bond yields as investors continue sell French government bonds/OAT*.
*OATS (Obligations assimilables du Trésor) – The primary medium and long-term sovereign debt instruments issued by the French government. These bonds are managed by the AFT (Agence France Tresor) and serve as the foundation bedrock for financing France’s state expenditure. Standard OATs are issued with fixed maturities ranging anywhere from 2 – 50 years.
However, it is not all doom and gloom, as last Friday 23rd October, top ratings agency Moody’s spared France a credit rating downgrade leaving it at Aa3 (High Grade Investment Grade), which is equivalent to an AA- rating with Moody’s and S&P (Standard and Poors) rating agencies. However, bond markets had been pricing in a downgrade for France by Moody’s as the other two rating agencies had already downgraded Frances’ sovereign rating to A+ (Upper Medium Investment Grade). In a statement, Moody’s said that “The Aa3 rating assumes that a deficit reducing budget for 2027 will be adopted, while financing costs and social tensions will abate somewhat in the next few months”.
