(Bloomberg) -- French government bonds lagged peers as investors weighed the challenges to Prime Minister Michel Barnier’s new cabinet and its ability to get the nation’s vast deficit under control.
The gap between French and German benchmark yields — a proxy for French risk — climbed to 80 basis points, the highest since early August. France’s 10-year note came within a whisker of yielding the same as lower-rated Spanish debt for the first time since the global financial crisis.
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A new French cabinet named late Saturday is a patchwork of conservatives and centrists who haven’t always worked smoothly together. Opposition blocs in parliament are threatening no-confidence votes that could topple the government, jeopardizing the administration’s ability to pass a budget through parliament over the coming weeks.
“France continues to trade with the extra political term premia,” said Pooja Kumra, rates strategist at TD Bank. “Markets are still waiting for some form of clarity from the budget.”
The extra yield investors demand to own French bonds over safer German peers has almost doubled since June, when President Emmanuel Macron blindsided markets and even his own allies by calling snap elections. The resulting hung parliament left no single party with a large enough majority to govern alone.
On Monday, the moves were compounded by data that showed the euro area’s private-sector economy shrank for the first time since March. France saw a particularly sharp drop in services sector activity after an Olympics-related bounce disappeared quickly.
The data prompted traders to amp up wagers on European Central Bank interest-rate cuts, with the probability of a quarter-point reduction next month rising to 40%.
Equity investors also remained on edge, with France’s CAC 40 Index underperforming the broader European sector. Shares of BNP Paribas SA, Credit Agricole SA and Societe Generale SA fell over 3%.
In a television interview Sunday, French premier Barnier flagged the risks of investors turning against France, in contrast with predecessors who have tended to stress the country’s good standing and dispute negative views on its creditworthiness.
“Let’s be really careful with France’s signature,” Barnier said. “A lot of our debt is on international markets — we must preserve France’s credibility.”
He also mooted higher taxes on wealthy individuals and large companies — an idea backed by Bank of France Governor Francois Villeroy de Galhau — to help plug France’s fiscal shortfall, which swelled to 5.5% of gross domestic product in 2023.
France will run the gauntlet of rating reviews from several agencies in coming weeks, after S&P Global Ratings already downgraded the country to AA- in May and the EU instigated a procedure to enforce greater fiscal discipline. France is rated Aa2 by Moody’s Ratings, while Spain is rated five levels lower at Baa1.
New Order
The turmoil in French markets has also accelerated a trend that’s been playing out since 2022, with investors increasingly demanding more compensation to hold France’s bonds over those of the European periphery given the country’s bloated debt pile.
The gap between Italian and French bond yields reached the narrowest since 2010 on Friday, at 59 basis points. The spread over Spain, meanwhile, has tightened from more than 50 basis points this time last year to nearly zero.
Investors have piled into Spanish bonds amid an improving economic outlook and a reduction in the nation’s elevated debt. Record tourist numbers, strong exports and a rapidly expanding population mean Spain has one of the highest growth rates in Europe despite the country’s fragmented government.
David Zahn, head of European fixed income at Franklin Templeton, said he’s long expected Spanish yields to trade in line or below those of France.
“Spain has fiscally consolidated quite well,” said Zahn, who has an overweight position in the country’s debt. “More and more people are saying, well, let’s buy from Spain rather than France.”
(Updates with context throughout. A previous version of this story corrected S&P credit rating in paragraph seven.)
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