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(Bloomberg) — France’s bonds are now judged to be riskier than those of Spain for the first time since 2007, a symbolic reversal pointing to the extent of its financial-market woes.
With Prime Minister Michel Barnier’s newly formed minority coalition struggling to get a grip on deficits after an inconclusive election, the shift in relative status shows how traders are increasingly projecting persistent disarray in Paris onto the price of the country’s debt.
Just days since his cabinet was sworn in, the higher risk premium now demanded by investors for French securities stands out all the more given the lower credit ratings bestowed on Spain, once a target of bond vigilantes during Europe’s sovereign crisis.
“As an investor, I’m not sure what’s going to happen with the current government or thereafter,” said Zurich Insurance Co’s chief market strategist Guy Miller.
The yield on 10-year French bonds traded at 2.98% on Thursday, slightly above their Spanish equivalents. The rate is already higher than that of Portugal, and is the closest it’s been in over a decade to similar-dated yields of Italy and Greece.
That switch shows how appetite for one of Europe’s safest assets is waning amid months of political turmoil, underscoring the danger that France could now become more permanently classed by investors alongside parts of the region typically associated with fragile public finances.
The country has been in the eye of a storm ever since Emmanuel Macron sought to bolster political stability by calling snap elections in June. The bet backfired, first as investors panicked that the far-right could take power, then as the election returned a National Assembly split between three bitterly divided blocs incapable of governing alone.
Macron spent the summer hesitating over appointing a government that wouldn’t immediately be toppled in a no-confidence vote. The cabinet finally chosen on Saturday combines centrists and conservatives from Barnier’s party, which won fewer than 50 of 577 seats in the National Assembly.
Deficit Risk
During the inertia of a caretaker government, France’s finances deteriorated further as tax receipts disappointed and local authority spending accelerated more than expected. The new government must cobble together a budget in the coming days as it nurses a deficit for this year that risks exceeding 6% of economic output.
Against that backdrop, the extra yield investors demand to hold France’s debt over safer German notes has widened to around 82 basis points from less than 50 basis points in June, when Macron called the election.
Opposition parties from the far-left to the far-right that improved their share of seats in parliament have campaigned to reverse many parts of Macron’s pro-business agenda, such as cutting taxes for investors and raising the retirement age.
Marine Le Pen’s National Rally, which would have a pivotal role in no-confidence votes to dismiss Barnier’s government, is keeping up the pressure by proposing legislation to undo the pension reform. While unlikely to succeed, it presents another challenge in the coming weeks.
“Any near-term adverse French political headlines, for example around the budget or pension reform repeal, could add momentum to this trend,” Barclays Plc rates strategists Max Kitson and Rohan Khanna wrote in a note. They say the case to have a long position in Spain versus France will only be undermined if “the Spanish domestic picture deteriorates meaningfully”.
France has slipped from its long-term plans to reduce the deficit, which swelled to 5.5% of gross domestic product in 2023.
Villeroy’s Warning
The previous government had pledged to reduce it to 5.1% this year and within European Union’s 3% limit by 2027, but officials including Bank of France Governor Francois Villeroy de Galhau have warned sticking to those plans would inflict too much economic damage.
The new government said it will present a 2025 budget around Oct. 9, a week later than French law prescribes. It has also delayed presenting its longer-term fiscal plan to Brussels until the end of October.
The new finance minister, Antoine Armand, said Wednesday there would be tough measures in the upcoming finance bills, focusing mainly on spending cuts. But the government has also said it is studying targeted levies on the wealthy and large companies, marking a deviation from Macron’s approach in the last seven years.
Barnier will give more clarity on his plans when he presents his policy agenda to parliament on Oct. 1, which will be the first opportunity for opposition lawmakers to call for a no-confidence vote.
The switch in the market’s view of French debt also reflects how investors have piled into Spanish bonds given the improving economic outlook there, and a reduction in borrowings that had swelled during the region’s debt crisis of the previous decade.
At the start of the year, Spanish 10-year bonds still paid upwards of 40 basis points over French peers. The Barclays rates strategists say Spain is likely to keep outperforming France, despite the recent sharp compression in the spread.
Record tourist numbers, strong exports and a rapidly expanding population mean Spain has one of the highest growth rates in Europe despite the country’s fragmented government.
“Right now, the tailwind is still with Spain, potentially an upgrade in terms of the debt dynamic in Spain, investor perception of the growth dynamic, even the political dynamic,” said Zurich’s Miller. “All these things together mean Spain is still in the ascendancy.”
–With assistance from Sujata Rao.
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