After the recent surprising victory of the left in French elections, uncertainty has engulfed the country, particularly impacting the financial markets, notably the government bonds.
The political deadlock in the French parliament has raised concerns among investors, as evidenced by the increase in the risk premium for French government bonds compared to their German counterparts.
The yield spread between French and German 10-year bonds stands at 62 basis points today, down from Friday’s 72 bps but still higher than the 47 bps at the beginning of 2024.
The recent elections in France have left the parliament divided and without a clear majority, leading to political uncertainty and prompting investors to rethink their strategies regarding French government bonds.
This uncertainty has caused a decline in French government bond prices, with a three basis points increase in the yield of 10-year bonds (Obligations Assimilables du Trésor), now at 3.16%.
Surveys predicted that Marine Le Pen’s Rassemblement National (RN) would become the largest party, but the election results split the National Assembly into three major groups (left, centrists, and far-right), each with different agendas and lacking a tradition of collaboration.
The political uncertainty is reflected in the French bond market yield curve, highlighting an uncertain economic outlook and debt pressure.
The French 5-year Credit Default Swap (CDS) value currently stands at 31.47 basis points, indicating an implied default probability of 0.52%, based on a presumed recovery rate of 40%.
This metric underscores the perceived risk associated with French sovereign debt.
An illustrative example of this situation is seen in the OAT TF 0.5% MG72 bond, maturing in May 2072.
The market has seen intensified selling of this bond in recent months, but it may have reached its low point.
Looking at various maturities, here is the current picture of French government bonds:
| Title | ISIN | Price | Yield |
|---|---|---|---|
| OAT 6% OT25 | FR0000571150 | 103.68 | 3.15% |
| OAT 2.5% MG30 | FR0011883966 | 97.58 | 3.02% |
| OAT 1.25% MG36 | FR0013154044 | 80.11 | 3.35% |
| OAT 4% APR55 | FR0010171975 | 106.5 | 3.7% |
| OAT 0.5% MG72 | FR0014001NN8 | 36.25 | 3.09% |
Analyzing the yield curve shows an unusual trend that provides investment opportunities for investors with a higher risk appetite.
This situation has further rattled investors, worried that left-wing policies may undermine many of the pro-market reforms enacted over the past seven years and hinder efforts to contain French public debt, which stood at 110.6% of GDP in 2023.
The left-wing alliance’s success has highlighted its campaign for a strong increase in public spending, exacerbating concerns about France’s budget and putting the nation on a collision course with the European Union, which is already taking steps to curb the budget deficit.
However, the left-wing alliance lacks an absolute majority, limiting its ability to implement radical changes.
Some strategists have suggested that a hung parliament could be a positive outcome for investors.
Aneeka Gupta, director of macroeconomic research at WisdomTree, said: “Advancing and passing any policy and implementing progressive reforms will be very difficult because every party vote is split, and nobody has an absolute majority.” However, Gupta added: “I think the markets will be relieved that we are avoiding this extreme right-wing situation”.
Vincent Mortier, group chief investment officer of Amundi, believes that fixed-income volatility should decrease when the political situation becomes clearer.
Mark Haefele, chief investment officer of UBS Global Wealth Management, notes that Paris’ fiscal situation will remain complex and constrain the next executive’s maneuvering room.
“In the short term, political news will continue to influence French government bonds, especially in medium and long maturities.
In terms of credit quality, France’s long-term outlook is deteriorating, and a rating downgrade is possible.
We prefer less volatile French corporate bonds to government bonds and see opportunities among investment-grade bonds of multinational corporations, which are less exposed to national political developments and offer interesting returns.”
Nomura economists expect the appointment of a centrist technocratic prime minister: “When this happens, political uncertainty will have eased, and we expect OAT-Bund spreads to narrow again”.
Investors may be positive about French outcomes after the initial nervous reaction.
Geoffrey Yu, senior strategist at the Bank of New York Mellon, said: “French politics confuse once again.
Based on the results, risks of expansive fiscal policy linger, and perhaps have risen at the margins”.
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