French-German Bond Yield Spread Returns to Pre-Crisis Levels

France’s borrowing costs just 15 bps away from German levels
Lower-rated euro zone bonds outperform as FDP risk fades

The gap between French and German borrowing costs moved to its tightest level since before the 2010-2012 euro zone debt crisis on Tuesday, as confidence in the euro zone’s prospects swelled and “Frexit” worries faded from memory.

Back in February, the spread between the government bond yields of the euro zone’s two largest economies widened out to as much as 80 basis points on a potential presidential win for anti-euro candidate Marine Le Pen.

But the win by centrist Emmanuel Macron and subsequent praise for his reforms has narrowed the gap sharply.

On Tuesday, France’s 10-year government bond yield spread over Germany tightened to 15 basis points, a level last seen in August 2009, well before a series of sovereign debt crises hit the single currency bloc.

“All the political uncertainty in France in the first half of the year has faded away and the market is focusing on macroeconomic factors,” said DZ Bank analyst Sebastian Fellechner.

The political calm in France stands in contrast to the political impasse in Germany, where Chancellor Angela Merkel raised the prospect of new elections after coalition talks collapsed this weekend.

Analysts also pointed to a generally positive sentiment towards the euro zone as another reason for tightening spreads across the bloc.

With major supply out of the way, European Central Bank largesse continuing to flow and with no major headline risks for the rest of the year, the market has no reason to bet against the euro zone at the moment, said ING strategist Benjamin Schroeder.

“All those shorting France have slowly been squeezed out and no-one is willing to take the opposite position now, with no obvious risks looming and with supply winding down,” said ING strategist Benjamin Schroeder. On Tuesday, the premium that investors demand to hold Italian debt over German was at 141 bps, close to a one-year low hit earlier this month.

All Southern European bond yields fell 4-6 bps on Tuesday, as investors continue to take advantage of the higher yields they offer in a benign environment.

The break down of a potential “Jamaica coalition” between Merkel’s CDU party, the pro-business FDP and the Greens may even be benefiting them, said Fellechner of DZ Bank.

“The (FDP) liberals would have been much more hard on the Southern European countries, so now that they refuse to work on a Jamaica coalition, that is good for peripheral spreads,” he said.


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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell