Rates Spark: Time Not On France’s Side

Tough to see French spreads tighten in the near term

EUR rates started the week better supported, which was mostly owing to oil prices sinking towards US$100/bbl and taking front to intermediate rates lower alongside. Risk sentiment also improved on the back of these developments. Within the European government bond space, this has helped pull back the 10y OAT/Bund spread to below 100bp – albeit only briefly.

At the end of last week, we had seen the spread-widening dynamic accelerate on the back of the French government’s planned €54bn efforts to bring the deficit back to 5%. It is an effort that will likely face strong political headwinds. But even beyond that, we argue that time is not in favour of French bond spreads. After this year’s budget, the focus will turn to the presidential elections. Those are likely followed by legislative elections and another potentially difficult government formation process.

The European backdrop is also less favourable. Coming out of Covid came with the sense of the crisis having instilled a greater sense of solidarity in the Union. Parsing the results of the German state elections but also looking at the strong polling of Le Pen in France, one now senses sentiment starting to turn again.

Without any positive developments in the Middle East and/or more encouraging headlines in the political arena, we think the 10y OAT spread could occupy a range of 100 to 125bp in coming months. And nervous eyes will increasingly turn to the European Central Bank for a solution. The hurdle for the ECB to engage in bond purchases might be higher in the current situation where the central bank is focused on inflation and eyeing further monetary policy tightening.

Tuesday's events and market views

Watch for some geopolitical headlines from the sidelines of the UN General Assembly this week, where President Trump is scheduled to meet Gulf leaders on Tuesday. There won’t be much in terms of data out of the eurozone, with preliminary consumer sentiment for September the only highlight. Consensus sees a slight worsening as the conflict in the Middle East has escalated again. Weak consumption growth remains a drag on the eurozone economy and is unlikely to turn more positive in this environment. There will be quite a few speakers from the ECB, though, including Nagel, Kocher and President Lagarde. We will be listening for comments that could push back against the hawkish market pricing.

The only noteworthy US data releases of the day are the Philadelphia Fed non-manufacturing and the Richmond Fed manufacturing indices. We will also get the ADP weekly payrolls' data. Scheduled Fed speakers for the day are Williams, Jefferson (on Treasury market functioning) and Barkin.

In government bond primary markets, both Germany and the UK will auction 5y bonds. Italy mandated banks for a new 12y green bond, which should be Tuesday’s business. The US Treasury will auction new 2y notes.