French spreads reach 84 basis points as the budget round meets a steeper Bund curve

A sovereign spread is supposed to price the probability that one government repays and another does not. In the euro area it rarely does that any more, and this week demonstrates why. The French ten-year closed 84 basis points above the equivalent Bund on Friday, 23 wider than in June, without a rating action, a failed auction or a change in the debt trajectory that anybody has published. What has changed is the price of duration everywhere, and France has more of it outstanding than anyone except Italy.

All three lines turn upward in the same month and none has a domestic explanation that arrived in July. Italy is 26 basis points wider since June with a fiscal position that has if anything improved, and Spain, which has the strongest growth among the large economies, is 11 wider. When the strongest and the weakest credits widen together against the benchmark, the market is repricing the benchmark.

The Bund itself is the moving part. German ten-year yields have risen 47 basis points since June against an unchanged policy rate, the same shape of move the ten-year Treasury has made and for the same reason. Defence and infrastructure spending has turned Germany from the scarcest safe asset in the region into a substantial net issuer, and a benchmark that supplies more paper each year has to pay more for it.

The budget round supplies the story that makes this legible. A minority government negotiating a deficit path without a reliable majority is a genuine source of uncertainty, and the first substantive votes fall in late October. But the market has watched three French budget rounds under similar arithmetic, and the spread widened a few basis points on each before retracing. Twenty-three basis points over a summer when parliament was not sitting is a different sort of move.

Clients want to talk about the budget because the budget is on television. The bid for long euro paper has been deteriorating since June and the politics is the excuse the market reached for.

Annika Sorbo, head of G10 strategy at Norwood Quay

• French debt has an average maturity of about 8.6 years, the longest among the large euro issuers, so a term premium shock does proportionally more damage to its funding cost.
• Domestic insurers reduced their holdings of long French paper for a fourth consecutive quarter, which removes the buyer that has historically absorbed the thirty-year point.
• The hedged yield pickup that drew Japanese buyers into euro sovereigns in the spring has narrowed to eight basis points against their domestic thirty-year, from forty-one in March.
• Euro area net issuance rises to an estimated 621bn euros next year, which is the largest figure in the currency's history and is met by a shrinking official portfolio.

The American connection runs through the currency. A euro based fund hedging a ten-year Treasury back to euros now earns less than nothing, because three month cross currency basis has widened to minus 42 basis points. Capital that spent three years travelling west has a reason to stay home, and at the front end that has supported euro sovereigns. At the long end it has not, because the domestic buyer wants the same compensation for duration the American buyer has started demanding.

The tell for the coming week is the thirty-year point rather than the ten. France has a long-dated syndication pencilled in for the second half of the month, and that order book will say more about the bid for European duration than any spread print. Above 60bn euros and the widening is politics after all. Below 35bn and the term premium reading is the right one on both sides of the Atlantic.