Published : 4 days ago, on 05/12/2024

By Stefano Rebaudo

(Reuters) – The risk premium investors demand to hold French debt rather than German Bunds dropped from its highest levels in over 12 years on Thursday after the widely expected collapse of the French government.

Far-right and left-wing lawmakers joined forces early this week to back a no-confidence motion against Prime Minister Michel Barnier.

The gap between French and German yields – a gauge of the premium investors demand to hold France’s debt – tightened 3 basis points (bps) to 80.90 bps. It hit 90 bps on Monday, its widest since 2012.

Given the price action in previous days, market participants had been expecting a muted reaction or even a ‘buy on rumours, sell on news’ response to the fall of the government.

Analysts said France will enter a slow-burning crisis that could lead to an ongoing deterioration of sovereign creditworthiness and less economic growth.

They recalled that in the draft budget bills, the government targeted 60 billions euros in spending cuts and tax increases to narrow the deficit to 5.1% of gross domestic product in 2025.

Ultimately, the very likely extension of the 2024 budget to 2025 implies a fiscal policy that is less restrictive than planned in terms of tax revenues and in line with what was planned in terms of public spending,” said Charlotte de Montpellier, senior economist, France and Switzerland at ING.

Euro zone borrowing costs edged up, with investors waiting for jobs data from the U.S., which could affect expectations for the Federal Reserve’s easing path.

Fed Chair Jerome Powell said on Wednesday that the U.S. economy is stronger than the central bank had expected in September, and he appeared to signal his support for a slower pace of interest-rate cuts ahead.

Germany’s 10-year government bond yield – the euro area’s benchmark – rose 2.5 bps to 2.08%. It hit 2.033% last week, its lowest since early October.

While strong U.S. Treasuries on the back of the disappointing Services ISM and softer labour market pointers stabilised markets in the late afternoon (yesterday), euro-valuation start to look stretched ahead of next week’s likely 25 bps European Central Bank rate cut,” said Hauke Siemssen, rate strategist at Commerzbank.

Bond prices move inversely with yields.

Italian bonds slightly outperformed their peers, with the gap between Italian and German yields hitting a fresh 35-month low at 112.30 bps.

(Reporting by Stefano Rebaudo; Editing by Toby Chopra)