French Debt Risk Premiums Decline as Macron Seeks New Prime Minister

By Stefano Rebaudo

French debt risk premiums compared to German Bunds decreased on Friday, following President Emmanuel Macron's announcement of a forthcoming appointment of a new Prime Minister. His primary focus will be on getting the 2025 budget through parliament.

Market Reaction

Expectations for EU-level joint funding stimulated the "convergence trade," tightening yield spreads against Bunds. The gap between French and German yields – an indicator of the risk premium for French debt – fell to 73.50 basis points, its lowest since November 21, ending the day down 3.5 bps at 74.50 bps.

Political Developments

Michel Barnier, the conservative prime minister, resigned just three months into his term after being voted out by parliament over fiscal decisions. Investors expressed concern that the resulting political turmoil might lead to extending the 2024 budget into 2025, which could compromise efforts to reduce a growing deficit.

In a twist, Marine Le Pen, leader of the far-right National Rally, who voted for Barnier's ousting, stated she wouldn't pursue efforts to remove Macron, suggesting the passage of a budget could occur within weeks.

"Her remarks indicate the political impasse may not be as severe as previously thought," noted Michiel Tukker, senior European rate strategist at ING. However, Tukker cautioned that satisfying Le Pen’s party would be a challenging task.

Broader Market Implications

The tightening of spreads impacted the broader market, affecting Italian BTPs and Spanish Bonos as well. On Friday, the yield spread between BTPs and Bunds fell to 105.40 bps, its lowest since October 2021, closing down 1 bp at 107.60 bps.

Michael Leister from Commerzbank highlighted that the prospects of joint European funding for defense are enhancing convergence in the trade.

Investors are hopeful for a €500 billion joint EU fund aimed at defense projects, tapping into bond markets to enhance expenditures while anticipating Donald Trump's potential return to the White House, as reported by the FT.

Meanwhile, euro area benchmark Bund yields are poised for their first weekly increase in over a month, following an uptick to 2% on Monday. Markets are awaiting significant U.S. economic data, which could influence expectations surrounding the Federal Reserve’s monetary policy. Germany's 10-year yield rose 0.5 bps to 2.11%, marking a weekly increase of 2 bps.

Next week, attention turns to the European Central Bank policy meeting, where investors largely anticipate a 25 bps rate cut while leaning away from a more aggressive 50 bps move. Many believe cuts below the neutral rate may be necessary as inflation risks decrease.

The neutral rate, posited by various analysts to be around 2%, represents the theoretical interest rate that would sustain full employment and stable inflation in the economy.