French debt risk premiums drop on budget hopes in broad convergence move

French debt risk premiums versus Bunds dropped on Friday as hopes grew that France may end up with a 2025 budget approved by parliament, while the prospect of European Union joint funding fuelled broader convergence among bond yields. French President Emmanuel Macron said he would appoint a new prime minister in the coming days, and his top priority would be getting a 2025 budget adopted by parliament.

French debt risk premiums versus Bunds dropped on Friday as hopes grew that France may end up with a 2025 budget approved by parliament, while the prospect of European Union joint funding fuelled broader convergence among bond yields.

French President Emmanuel Macron said he would appoint a new prime minister in the coming days, and his top priority would be getting a 2025 budget adopted by parliament. Investors had worried the most likely outcome was an extension of the 2024 budget to 2025, implying a less restrictive fiscal policy which would have threatened the government's ability to curb a burgeoning deficit.

The gap between French and German yields – a gauge of the risk premium investors demand to hold French debt – hit 72.40 basis points (bps), its lowest since Nov. 21. It was last down 4 bps at 76.20 bps. "Her (Marine Le Pen) comments suggest the political deadlock may not be as stuck as suggested over the past few days," said Michiel Tukker, senior European rate strategist at ING.

"Of course, these are just words, and reaching a credible government budget that satisfies Le Pen's party will prove a challenging task." Far-right National Rally leader Marine Le Pen, who voted to oust Barnier, said on Thursday that a budget could be passed within weeks.

"Le Pen can bide her time, waiting to push for new parliamentary elections in July next year," said Mark Dowding, chief investment officer at RBC BlueBay. "In the short term, this means that France remains a structurally deteriorating credit," he argued. RBC BlueBay said its positioning in OATs remains flat for now, but it would look for opportunities to go short in 2025 if spreads narrow.

Peripheral euro zone bond spreads also tightened following a FT report that EU countries are discussing a 500 billion euro joint fund for common defence projects and arms procurement. The yield spread between Italian BTPs and safe-haven German Bunds dropped to 105 bps on Friday, its lowest level since Oct. 2021. It was last down 2.5 bps to 106.40 bps.

"BTPs are taking another major leap as prospects of more joint funding on the European level for defence is boosting the convergence trade," said Michael Leister, head of interest rates strategy at Commerzbank. "The convergence momentum (among euro area government bonds) remains strong also given the overriding demand for carry."

Markets await U.S. payrolls later in the session that could shape expectations for U.S. interest rates. Germany's 10-year yield rose 2.5 bps to 2.12% and was set to end the week 2 bps higher - on track for its first weekly rise in over a month.

Markets await a European Central Bank policy meeting next week.

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