By Stefano Rebaudo
(Reuters) – French debt risk premiums versus safe-haven German Bunds fell on Friday, after French President Emmanuel Macron said he would appoint a new prime minister in the coming days and his top priority would be getting a 2025 budget adopted by parliament.
Meanwhile, hopes for joint funding at the European Union level fuelled the so-called “convergence trade”, tightening yield spreads versus Bunds.
The gap between French and German yields – a gauge of the risk premium investors demand to hold French debt – fell to 73.50 basis points, its lowest since Nov. 21. It was last down 3.5 bps at 74.50 bps.
Michel Barnier, a veteran conservative, became the shortest-serving prime minister in modern French history when he resigned on Thursday after parliament voted him out over his fiscal plans, barely three months after he was appointed.
Investors have worried that the most likely outcome of the resulting political crisis was the extension of the 2024 budget to 2025, implying a less restrictive fiscal policy threatening the ability of the government to curb a burgeoning deficit.
Far-right National Rally (RN) leader Marine Le Pen, who voted to oust Barnier, said on Thursday she had no plans to seek the removal of Macron and a budget could be passed within weeks.
“Her comments suggest the political deadlock may not be as stuck as suggested over the past few days,” said Michiel Tukker, senior European rate strategist at ING.
“Of course, these are just words, and reaching a credible government budget that satisfies Le Pen’s party will prove a challenging task.”
According to Tukker, “the spread tightening was felt more broadly throughout rates markets”, also affecting Italian BTPs and Spanish Bonos.
JOINT FUNDING PROSPECTS
The yield spread between BTPs and Bunds dropped to 105.40 bps on Friday, its lowest level since October 2021. It was last down 1 bp to 107.60 bps.
“BTPs are taking another major leap as prospects of more joint funding on the European level for defence is boosting the convergence trade,” said Michael Leister, strategist at Commerzbank (ETR:CBKG).
Yield spreads have tightened on market hopes for joint issuance from the European Union, which could fund growth and ease the debt burden for over-leveraged economies.
EU countries are discussing a 500 billion euros joint fund for common defence projects and arms procurement, tapping bond markets to boost spending in anticipation of Donald Trump’s White House return, the FT reported on Thursday.
Meanwhile, euro area benchmark Bund yields were on track for their first weekly rise in more than a month after reaching 2% on Monday as markets await key U.S. data later in the session.
U.S. payrolls could affect expectations for the Federal Reserve monetary easing path.
Germany’s 10-year yield rose 0.5 bps to 2.11% and was set to end the week 2 bps higher.
Markets await the European Central Bank policy meeting next week, with investors fully pricing a 25 bps rate cut and no chance of a 50 bps move, while focusing on the rate outlook.
Many think the central bank will have to cut below the neutral rate as inflation risks falling below target.
The neutral rate – which many analysts see at 2% – is the theoretical interest rate that would keep the economy operating at full employment and stable inflation.