Following the recent European elections, the French government bond market experienced significant stress, with the 10-year OAT-Bund spread widening sharply by 7-8 basis points. This widening reached the widest levels seen since last year, indicating a high level of uncertainty and concern among investors. The market reaction isn’t surprising given the backdrop of political and economic instability in the region.
The downgrade of France’s sovereign credit rating by Standard & Poor’s to AA- from AA further exacerbated the situation. The agency cited budgetary concerns as the main reason for the downgrade. Last year’s larger-than-expected budget deficit of 5.5% of GDP, attributed to weak growth and soft revenues, raised alarm bells among investors and financial institutions. Macron’s government was already facing challenges in fiscal consolidation, and the downgrade only added to the pressure.
Economists from ING anticipate that the European Commission may initiate its Excessive Deficit Procedure against France, which could have significant repercussions for the euro. The response of France’s next government to this procedure will be crucial in determining the country’s future economic trajectory. With the possibility of Marine Le Pen’s RN party gaining a significant vote share in the upcoming elections, the focus shifts to potential coalitions and their policy implications.
Challenges for the Euro
In the current climate, the euro is expected to face difficulties in rallying, with predictions suggesting it will hover around the 1.07/08 mark, subject to downside risks. The market response to political and fiscal uncertainties in France is reflected in the EUR/USD exchange rate facing strong resistance at the 1.0800 level. The combination of political instability and concerns about fiscal policy in France is weighing on the euro’s performance.
Central Bank Response
Attention is now turning to eurozone speakers, including European Central Bank Chief Economist Philip Lane, who is expected to address the current economic challenges. Despite the ECB’s reluctance to commit to further easing measures, the central bank may need to take a firm stance in the short term to mitigate the impact of a weakening euro on disinflation. The market is closely watching for any signals from the ECB regarding future monetary policy decisions.
The outcome of the upcoming elections in France and the response of the government to economic challenges will be critical in determining the future trajectory of the French bond market and the euro. Investors and market participants are closely monitoring developments in the region for any signs of stability and policy direction.