Rates Spark: Not The End To France's Problems

Whilst the negative outcome from the confidence vote was expected, it does highlight the uncertain path towards France's fiscal consolidation. The most probable way forward is the appointment of a new prime minister, but preparing a budget that will pass parliament seems difficult. The spending cuts will likely need to be watered down to garner broader political support.

French government bond (OAT) yields are unlikely to tighten materially from here, we think, while the upside potential is still significant. The 10Y OAT-Bund spread is still some 10bp tighter than the peak last November when Barnier's government fell. Compared to then, we now have the possibility of new parliamentary elections, which only complicates the puzzle further and keeps uncertainty high.

Spillovers to the broader eurozone market are limited so far, but a prolonged escalation could see lower swap rates. While the hurdle for pricing in more European Central Bank easing is high, for longer rates we do see risk sentiment as a potential bullish factor. The combination of worsening US economic data and headlines from France may limit the upside potential for 10Y swap rates for now. Having said that, as long as Macron is president, likely until the 2027 elections, we don't expect a blow-out of OAT spreads and a broader shock to risk sentiment.

US Treasuries are trading with a bullish undertone since the weak set of labour data over the past week. That puts the focus squarely on the preliminary benchmark revisions to payrolls for the 12 months to March 2025. As our economist notes, other quarterly census reports already point to a downward revision of data between March and December 2024 of 857k. This would be a big change in the job market narrative and could fuel questions of why the Fed shouldn't cut by 50bp this month. Ahead of the revision, we will also get the NFIB small business optimism index, which is expected to change very little, if not slightly improve.

Primary markets will be busier with the EU selling new 5y and new 30y bonds via syndication. The Netherlands taps an 11y bond for up to €2bn, Austria a 9y for €1.2bn and Germany two green Bunds for €1.5bn. The UK auctions 18y gilts for £4bn while the US Treasury will sell US$58bn in new 3y notes.

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