Le Pen’s rise sets up the French debt market for years of pain

(Bloomberg) — Bond investors will set a higher interest rate on French government borrowing for years, in a regime change that could have far-reaching consequences for Europe’s second-largest economy.

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Even if Marine Le Pen’s National Rally does not have an outright majority in the next vote, Insurance Company Zurich and Neuberger Berman say the market will continue to demand a higher yield to buy French debt. Others, including Societe Generale SA, predict the political uncertainty that has weighed on bonds will continue until the 2027 presidential election.

Since President Emmanuel Macron called a snap vote earlier this month, the yield on 10-year French bonds has risen more than 30 basis points against German securities and is now settled just below 80 basis point – a level seen for the last time during the eurozone. The sovereign debt crisis more than a decade ago.

“We’ve had a step change of where France is going to trade compared to Germany,” said Guy Miller, head of market strategy at Zurich Insurance Company. “I just don’t think French bonds will trade again at the level of the spread they had in the past.”

The drivers for repricing are twofold. Le Pen’s party, which has a significant lead in the polls, has defended several costly budget measures despite growing concerns about France’s debt burden – although she has scaled back some of the promises in recent days as she seeks more credibility. for economic issues.

And there is a fear – at least on the fringes – that the rise of the far right would disrupt relations with the EU and could one day pose a challenge to the eurozone’s existence.

If French bond yields are likely to settle higher, there are far-reaching consequences for the economy. France’s finance ministry estimates that the higher borrowing price would cost the state an extra 800 million euros ($859 million) a year. If the level continues, after five years the additional annual cost would be around €4 billion to €5 billion and €9 billion to €10 billion after 10 years.

Societe Generale warns that this risk premium is likely to remain even if Macron’s party surprises pollsters by winning a parliamentary majority in the coming weeks. This is because a stronger far-right contingent could further complicate the law-making process and hinder reforms.

The story continues

Even in the “best-case scenario” for majority markets for Macron’s party, “the idiosyncratic premium on French bonds could shrink but not disappear completely,” said Adam Kurpiel, head of rates strategy at Societe Generale.

In this scenario – which undercuts current polls – the Franco-German spread could tighten but not below the 50-55 basis point mark, he added, while a victory in the Rally National could see the spread find a new balance at 75 – area up to 90 basis points.

“The risk of an OAT regime change may be underestimated by the authorities,” Kurpiel said.

France’s first bond sale since Macron called snap elections this month went ahead as planned on Thursday, a sign that yields are high enough to lure new buyers. The Paris Treasury raised 10.5 billion euros ($11.3 billion) through auctions of three- to eight-year bonds, matching the upper end of their target — though given how active traders tend to be in these sales, the results could be don’t necessarily sound all clear.

Strained finances

The election battle is putting the spotlight on the country’s already strained finances. Without further measures to rein in the budget, the International Monetary Fund said debt would rise to 112% of economic output in 2024 and rise by about 1.5 percentage points a year in the medium term.

The European Union reprimanded France on Wednesday for a deficit that exceeds the bloc’s 3% limit, and S&P Global Ratings downgraded its sovereign credit score just last month.

“The fiscal situation is not good,” said Robert Dishner, senior portfolio manager at Neuberger Bermam.

French bond surge raises hierarchy in Europe’s debt markets (1)

However, the Franco-German spread settling around current levels is not necessarily cause for panic, according to Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International.

“The market is pricing in more of a risk premium, but we’re not expecting a full-blown sovereign crisis,” Ahmed said on Bloomberg TV. “The France-Germany spread at 120 basis points would be worrying, we are some way from that.”

Others predict that the momentum of expansion is not over. Federated Hermes predicts the yield gap will widen by 90 basis points in the run-up to the election, while Capital Economics says 100 basis points could be the new normal.

“There could still be a lot of volatility,” said Chris Iggo, chief investment officer at AXA Investment Managers. “It’s hard to see the spread going back to where it was three or four weeks ago.”

–With assistance from Sujata Rao, Naomi Tajitsu and James Hirai.

(Adds details from Thursday’s French bond auction in paragraph twelfth.)

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