French Bond Market Risk Jumps to One-Month High on Budget Fears

(Bloomberg) -- A gauge of French bond risk surged to its highest in a month as markets fret about the country’s budget negotiations and a looming review of its sovereign rating.

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The premium investors demand to hold France’s debt over regional haven Germany has climbed every day this week and is set to close at the highest since early October. That puts it back near the 80 basis-point level breached when a snap election called in June sparked months of political uncertainty.

The latest moves reflect worries over whether far-right leader Marine Le Pen could back a no-confidence motion that would topple Michel Barnier’s government and derail its 2025 budget plans. On top of that, the country sold more bonds on Thursday and its heavy debt burden will face scrutiny at the end of the month from S&P Global Ratings.

“It seems to me that supply, Le Pen headlines, S&P around the end of the month and risk-off is all a bit of a toxic mix for OATs,” said Evelyne Gomez-Liechti, a strategist at Mizuho International Plc, referring to the market term for French government bonds.

The selloff in French debt is being compounded by market-wide risk aversion as the war in Ukraine reaches a dangerous new phase. That’s also hurt other lower-rated euro-area peers such as Italy, though its debt-risk gauge remains near the narrowest this year.

For France, a vote of no confidence to block the budget and bring down Barnier’s government would be catastrophic for its public finances after efforts to contain the deficit already slipped off course this year. Last month, both Fitch Ratings and Moody’s Ratings put a negative outlook on France, and Scope downgraded it.

The current budget plans look set to win approval from the European Union, though the bloc’s executive arm is still seeking more clarity on certain reforms. The initial version presented last month to parliament promised €60 billion ($63.1 billion) of tax increases and spending cuts to bring the gap back to 5% of economic output from an expected 6.1% this year.

Nicolas Forest, chief investment officer at Candriam, said the recent widening in French bond spreads, though modest, shows the market “is doing its job” as the process reaches its final stages.

“The water is simmering, not boiling, yet,” he said in an interview. “There’s a stage at which it’s normal for investors to take into account the possibility that the government won’t make it til the end of the year, in which case the uncertainty would be total.”

The 10-year French spread over Germany was on course to jump by the most in three months on Thursday to around 79 basis points.

Agents of Chaos

Barnier, far short of a majority in parliament, will likely have to use a constitutional provision known as the 49.3 to adopt the budget without a vote when it returns to the National Assembly in December, after debate in the Senate. However, using that tool raises the likelihood that left-wing lawmakers will propose a no-confidence motion, which would crush the bill and topple the government if a majority backs it.

Le Pen’s party would likely have the deciding votes in such a scenario. She and her lawmakers initially took a constructive position, saying they did not want to be the agents of chaos in France’s attempts to repair its finances.

But Le Pen has repeated warnings in recent days, saying Barnier hasn’t taken on board the National Rally’s proposals during parliamentary debate. Speaking on French radio RTL on Wednesday, she said measures that would hurt consumer incomes are a red line for her party.

“If this red line is crossed, we will vote for a censure,” she said. “There is no difficulty on that, and I’m saying that in the clearest way possible.”

--With assistance from Nayla Razzouk.

(Updates level of risk premium.)

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