French sovereign risk premium has hit eurozone crisis levels

A key gauge of investor confidence in French government debt, the premium investors demand to hold 10-year bonds versus their German sovereign peers, reached a 15-year high on Thursday, returning to levels last seen during the eurozone debt crisis. Concerns about the country’s public finances and ongoing protests are weighing on market sentiment, Reuters reported.

The yield spread between French and German 10-year government bonds widened to 177.7 basis points. It last reached that level in November 2011, at the height of the eurozone debt crisis, when markets feared the European Union could break apart, Bloomberg reported.

France’s benchmark 10-year sovereign yield climbed to 5.14% in Thursday’s trading, its highest since July 2002. Two-year yields rose 11 basis points, an unusually sharp one-day move for a developed-country bond market, Bloomberg noted. Meanwhile, France's CAC 40 stock index fell 1.4% on Thursday.

Political uncertainty ahead of France’s presidential election next year, combined with difficulties passing a budget, is putting pressure on the market. The government has promised to step up security for further protests planned for Saturday, deploying troops alongside additional police, Reuters reports. Meanwhile, rising energy prices are fueling expectations of European Central Bank rate hikes, adding to the pressure on highly indebted countries such as France.

Yield spreads over German Bunds widened across the euro zone. Belgium’s 10-year spread increased more than 10 basis points to its widest since 2012, while Italy’s widened 10.5 basis points, Spain’s 7.5 basis points, and Greece’s 8.5 basis points.

The key question is whether the ECB will intervene if market tensions intensify, Nomura senior European economist Andrzej Szczepaniak told Reuters. “We believe the bar for the ECB to intervene is very high,” he reckons. In his view, intervention would come only if France’s problems spread to other markets and hampered the ECB’s ability to influence borrowing costs.

Aegon Investment Management portfolio manager Irina Kurochkina said that the ECB could stabilize the market by signaling that the surge in yields had tightened financial conditions too abruptly. Such a signal would temper expectations of further rate hikes and support bonds. Traders are currently pricing in three rate hikes by the end of next year, Reuters reported.

“Political gridlock and public anger over the high cost of living are making it virtually impossible to repair public finances ahead of next year’s French presidential election,” said Elias Haddad, senior markets strategist at Brown Brothers Harriman & Co.

There are few catalysts that could restore investor confidence in French government debt in the coming months, according to Henrietta Pacquement, fixed-income chief operating officer at Allspring Global Investments.

Europe has better safeguards against a debt crisis than it did in the early 2010s, and France does not face the banking stresses that engulfed Greece and other countries at the time, said Craig Veysey, a portfolio manager at Guinness Global Investors. However, he believes the selloff could spread to German Bunds should investors begin to fear that Germany will have to issue more debt to support more heavily indebted countries, Bloomberg reported.

Europe is better equipped to handle crises today than it was 15 years ago, and European institutions have grown stronger, in the view of Citi economist Giada Giani. “But re-emerging euroscepticism is a constraint here,” she cautioned.