After only 26 days French prime minister Sebastian Lecornu has resigned, resulting in French government bonds hitting the headlines.
The result is a further jump in 10-year French OAT bond yields to 3.6%, and a widening of the 10-year bond spread versus German bunds to almost 90 basis points – this is close to its highest level since the European Sovereign crisis in late 2009.
“In a sign of how times have changed, 10-year French government bonds now yield more than 10-year Italian BTPs – but given the relative improvements in the Italian fiscal story and the ongoing fiscal mess in France, it is difficult to argue that markets are wrong in pricing them this way,” said Colin Finlayson, investment Manager at Aegon Asset Management.
While the recent twists and turns in the French political story this year have only had only a fleeting impact on financial markets, there is reason for additional caution, noted Finlayson.
“This is because the prospect of fresh elections to find a new prime minister is growing ever likely,” he added. “This could be seen as an attempt by Macron to call the bluff of the electorate and test their support of both the Left and the Right of French politics. It’s a gamble which has taken before.”
Lurking in the shadows is another risk.
Last month Fitch downgraded the French Sovereign to ‘A’, moving it even further from its historical position of AAA and closer to that of Spain, Italy and others.
With Moody’s scheduled to review their rating on the 24 October and S&P a month later, there is a very real risk of both agencies also downgrading France to ‘A’.
“This could lead to some forced selling by some institutional investors, who are unable to hold bonds below a certain ratings threshold,” added Finlayson. “It may cause a reduced level of demand from other investors – such as amongst some central banks – who tend to shy away from assets with elevated levels of volatility.”
From an investor perspective, could this get worse before it gets better?
“Yes – the spread versus bunds could still move wider but the potential for an ECB backstop if markets become disorderly, and support more broadly from the EU, could mean that the extent of further relative underperformance may well be contained,” said Finlayson.
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