How bond investors soured on France

Something unusual is going on in European bond markets. A fortnight ago the yield on French ten-year government debt surpassed that of Spain, suggesting investors see the euro zone’s second-largest economy as riskier than its southern neighbour’s (see chart 1). That is quite the turnaround. In January Spanish yields were 0.4 percentage points higher than their French equivalents; at the worst of the euro-zone crisis, the gap was nearer five full percentage points. French borrowing costs are now well above the levels of Portugal and closer to those of Greece and Italy than they are to Germany’s.

Investors were once willing to give France the benefit of the doubt, even as it racked up debt. What has spooked them is the political turmoil following President Emmanuel Macron’s decision to hold snap elections in July and the precarious minority government that has resulted. Government debt stood at 111% of GDP at the end of March, well above the European Commission’s recommendation of under 60%. On October 10th, after we published this, Michel Barnier, the new prime minister, was due to unveil a budget that included tax rises and spending cuts. But his government faces an uphill task getting the budget passed.

The reversal in French and Spanish yields also reflects developments south of the Pyrenees. Spain’s economy grew by 2.7% in 2023, boosted by a strong job market and a booming tourism industry, well above France’s sluggish 0.7% expansion.

Spain also lacks a majority government. Oddly, though, European bond managers have in recent years seen this as a fiscal strength. Rather than haggling over budget-setting, Pedro Sánchez’s minority left-of-centre government has taken to rolling forward previously passed fiscal plans. This has helped keep a lid on spending.

Despite the diverging fiscal and economic outlook, France retains a higher credit rating than its southern neighbour. That makes French bonds look cheap relative to their current rating (see chart 2). But some investors believe the gap probably reflects expectations of a downgrade. Fitch and Moody’s, two rating agencies, are due to review their ratings for France on October 11th and 25th, respectively. S&P, another agency, will follow suit on November 29th.

For the past 15 years France has benefited enormously from the fact that the euro zone’s southern members were in a bad way. International investors wanted exposure to euro-denominated public debt. But the fiscally prudent northern member states, such as Germany and the Netherlands, issued too few bonds to satisfy them, and Greek, Portuguese and Spanish debt was deemed too risky. French bonds became attractive by comparison.

Since then, however, Greece, Portugal and Spain have undertaken painful fiscal adjustments. France’s weak growth, high debt levels and volatile politics are not an attractive offer for investors now that other options are available.■

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