Macron's Weakened Grip Sparks Surge in French Bond Yields

The demand for French government bonds surged to its highest since 2017 as President Emmanuel Macron's power waned. The political upheaval, coupled with snap elections and market fears over far-right agendas, caused investors to seek refuge in German bonds, driving down yields and affecting European markets.

The premium investors demand to hold French government bonds leapt to its highest level since 2017 on Friday, as President Emmanuel Macron's grip on power weakened after left-wing parties united against him, convulsing the country's markets once again. German government bond yields tumbled as investors took shelter in the country's debt, a traditional safe-haven asset, while European stocks slid and the euro declined. Yields move inversely to prices.

The difference between French and German 10-year borrowing costs rose to 78 basis points (bps) on Friday. It was the highest since 2017 on an intraday basis. "Risk aversion has plagued the French bond market," said James Briggs, corporate credit portfolio manager at Janus Henderson Investors. "This reflects ... fears around France's management of its precarious debt situation."

Investors have sold French assets since Macron gambled and called a snap parliamentary election on Sunday in response to a resounding victory for the far right in the European Parliament. Market participants fear the far right, led by Marine Le Pen's Rassemblement National, will win the election and push a high-spending agenda that will add to France's already large debt load.

Much of the widening in the closely watched yield spread has been caused by a fall in German yields as investors bet central banks are more likely to cut interest rates after weaker-than-expected U.S. inflation and jobs data, and snap up safe assets. Germany's 10-year bond yield was last down 14 bps at 2.35%, its lowest since mid-April, and set for the biggest daily drop since October. France's equivalent was down 5 bps at 3.14%.

Jussi Hiljanen, head of European rates strategy at SEB, said a decision by index provider MSCI to exclude European Union bonds from its indexes was also likely adding to the rally as investors sold EU debt and bought German. "Owing to the French elections at the end of this month, we probably will not see any sizeable tightening (in spreads) in the coming weeks at least, and we may see some further widening due to the political uncertainty," he said.

Market analysts said the decision by France's left wing parties to form a 'Popular Front' to contest the snap election was one driver of the market moves, saying it dents Macron's chances of coming out victorious. "There is a possibility that a far right candidate could become the next prime minister of France," said Mohit Kumar, chief economist for Europe at Jefferies.

"Market concerns range from a stalling of the (debt) reform process, possible rating downgrades to increasing concerns over talk of a breakup in the euro area." The concerns over the French election have hurt the bonds of other indebted countries, with the Italian-German yield spread rising to 159 bps, its highest since February.

Italy's 10-year bond yield was down 2 bps at 3.93% on Friday, dropping 4.5 bps for the week, compared with a 25 bps fall in Germany's equivalent yield. Germany's 2-year bond yield, which is sensitive to European Central Bank interest rate expectations, was last down 13.5 bps at 2.76%, after hitting 2.709%, its lowest level since mid-February.