(Bloomberg) — A measure of French bond risk rose to levels last seen during the euro-area debt crisis as a political standoff over the country’s budget threatens to bring down the government.
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The premium investors demand to hold 10-year French government bonds over German bonds climbed three basis points to 89 basis points on Wednesday, the highest level since 2012. The potential fall of the current government could still drive it higher — potentially all the way to 100 basis points, or 1 percentage point, according to Citigroup Inc. strategists.
The market nerves reflect investor concerns over Prime Minister Michel Barnier’s ability to pass a budget for next year and enact spending cuts to reduce the country’s deficit. The far-right National Rally party’s Marine Le Pen has vowed to bring down his administration with a no-confidence motion if its demands are not met, with the matter likely to come to a head in December.
Adding to the unease, Le Parisien newspaper reported that President Emmanuel Macron believed that Le Pen would carry out her threats, and that Barnier would be ousted soon by a no-confidence vote. Macron’s office denied he made such comments. Barnier warned the country faces a “storm” in financial markets if his budget proposals are rejected and the government is voted out of power.
French Premier Warns of Market ‘Storm’ If Budget Voted Down
“We could very well come to a situation where the government is again put into jeopardy,” said Greg Hirt, global chief investment officer for multi asset at Allianz Global Investors. “It could well be that we end up with a spread to bunds at the level of Italy.”
That would be unprecedented during the era of the euro, given lower-rated Italian bonds are historically among the highest-yielding in the region due to the country’s high debt load. Italian debt trades at a premium of around 125 basis points to Germany, and it would take that kind of level for France to become a longer-term buying opportunity, Hirt said.
The concerns over France, sparked in June by Macron calling a snap election, still pale in comparison with the market panic seen during the region’s debt troubles over a decade ago, when the French bond spread was more than twice as high. There are signs investors are starting to factor in a potential broader crisis, with a credit gauge of the risk that the nation leaves the euro area rising to near its highest level this year.
Bank strategists are also sounding fresh warnings. Citigroup said Tuesday that the bond spread may reach 100 basis points quicker than expected, while Commerzbank AG is telling clients to reduce exposure to France. The country’s benchmark stock index has slumped in recent months to underperform peers.
“Besides the recent political headlines underscoring that the budget agreement will become difficult and could bring the government down, the macro outlook is also deteriorating quickly,” Christoph Rieger, Commerzbank’s head of rates and credit research, wrote in a note.
The country’s central bank chief has called for more certainty around plans to repair the country’s finances. Data last week showed private-sector business activity in France plunged at the quickest rate since the start of the year, a sign that political and geopolitical concerns are weighing on sentiment.
France’s finances are about to face scrutiny from S&P Global Ratings on Friday, which could be the next catalyst for market moves, after both Fitch Ratings and Moody’s Ratings gave it a negative outlook last month.
Given the lack of a majority, Barnier is widely expected to use a constitutional provision in December known as 49.3 to adopt the bill without putting it to a vote in the National Assembly.
But using the tool raises the likelihood of a no-confidence vote that would bring down the government and reject the budget bill. The left has pledged to propose such a ballot, which would pass if Le Pen’s National Rally lawmakers back it.
The far-right leader has raised pressure on Barnier in recent days by reiterating that the current budget proposals are unacceptable and bringing down the government would not be a catastrophe.
“I was in France meeting different clients and the bearishness I’ve seen on their own country, from French asset managers, struck me — they’re not buying,” said Amedeo Scippacercola, head of European government bond trading at Mizuho International Plc.
Given the financial concerns, one fund manager in Tokyo is turning to alternatives in the region. In recent years, Japanese investors have been prominent investors in French government debt.
“One can avoid French bonds because the fundamentals of Spain seem to be good,” said Takashi Fujiwara, Head of Fixed Income Management and Chief Fund Manager at Resona Asset Management. “We will invest in German bunds and in surrounding countries we will look at Spanish and Italian bonds first.”
–With assistance from William Horobin, Ania Nussbaum and Hidenori Yamanaka.
