The aftermath of the European elections has left the French government bond market in a state of tension. The widening of the 10-year OAT-Bund spread by 7-8 basis points suggests a significant level of stress, with levels reaching their highest point since the previous year. This escalation follows the recent downgrade of France’s sovereign credit rating by Standard & Poor’s, dropping from AA to AA-. The downgrade came as a result of concerns over the country’s budget, particularly the larger-than-expected deficit of 5.5% of GDP in the previous year.
The budget deficit was attributed to weak growth and soft revenues, adding to the existing fiscal consolidation challenges faced by Macron’s government. The fear now is that any potential National Rally (RN) government might adopt a fiscally stimulating approach akin to that of President Trump. Economists at ING predict that the European Commission may trigger an Excessive Deficit Procedure against France on June 19, potentially leading to significant consequences for the euro. The response of the French government to this procedure will be crucial moving forward.
As upcoming elections loom, polls indicate that Marine Le Pen’s RN party is expected to secure a significant vote share but may fall short of an outright majority. This raises concerns about potential coalitions and their implications for policy. In this uncertain climate, the euro’s performance is expected to be challenged, with forecasts suggesting it will remain around the 1.07/08 mark, with risks leaning towards the downside. The focus now shifts to key eurozone figures, such as ECB Chief Economist Philip Lane, who could provide insights into the central bank’s approach.
Despite the ECB’s hesitance to commit to further easing measures, the market has already priced in additional easing for the year. However, the central bank may need to take a decisive stance in the short term to counteract the impact of the weakening euro on disinflation. The EUR/USD exchange rate is currently facing resistance at the 1.0800 level, reflecting market sentiment towards the various political and fiscal uncertainties in France. The confluence of these factors is likely to shape the bond market’s trajectory in the near future.