Euro zone bond yields fell on Tuesday and the spread between French and German 10-year yields narrowed further from its peak of last Friday as investors assessed whether the recent surge in France’s risk premium had gone too far, too quickly.
French borrowing costs have surged in recent weeks and the yield gap over Germany expanded to its widest level since the euro zone debt crisis in 2011 on Friday, due to worries about the country’s deteriorating fiscal situation ahead of next year’s presidential election.
The selloff has eased slightly this week with the yield gap, measuring the risk premium investors demand to hold French debt over German, now at 128 basis points. It touched its highest level in 15 years on Friday at 158 bps.
France is set to formally submit its 2027 budget on Tuesday, while far-right presidential candidate Marine Le Pen presented plans on Tuesday to reduce the country’s public deficit to 3 per cent by 2030.
“The French politicians have realised how difficult the situation is,” Jens Peter Sørensen, chief analyst at Danske Bank, said.
“They’re waking up to the reality, they will make a budget and they will tighten the budget.”
French Finance Minister Roland Lescure said the turbulence in the bond market had not reached the point to begin thinking about using policy tools from the European Central Bank to stabilise borrowing costs.
France’s 10-year bond yield was down 12 bps at 4.745 per cent on Tuesday, while Germany’s dropped 4 bps to 3.452 per cent. Italy’s 10-year bond yield also fell sharply, down 13 bps at 4.525 per cent.
The ructions in the bond market have prompted investors to trim their expectations for interest rate hikes from the ECB, while a third straight daily fall in oil prices has also tempered the need for additional tightening.
Brent crude futures were down 2.4 per cent on Tuesday to below US$98 a barrel on signs that exports from the Middle East were increasing closer to pre-war levels.
Meanwhile, ECB officials, including chief economist Philip Lane, have started to question the need for higher interest rates if rising bond yields impact growth and quell price pressures.
“On balance, most ECB members sound less hawkish,” said Christoph Rieger, head of rates and credit research at Commerzbank, who noted that policymakers are still keeping comments on the bond market to a minimum.
Markets are now pricing in an 85-per-cent chance of another rate hike by the end of the year. Futures had implied at least three more hikes by the March meeting but now markets are fully pricing in fewer than two quarter-point rate rises.
Germany’s two-year yield, which is sensitive to changes in interest rate policy expectations, was up slightly on Tuesday at 3.072 per cent.