With all that is happening in markets, there are plenty of charts worth watching in Europe right now. However, this in particular may be one of the most important.
The gap between French and German 10-year bond yields has surged over the past month, as investors are demanding a much bigger premium for holding French government debt over German bunds. The move looks even more striking when you zoom out on the charts.
The yield spread has decisively broken above the roughly 80 bps area that had capped it over the past couple of years. And even after pulling back from above 150 bps last week, it is still sitting around 135 bps currently. For some context, those are levels last associated with the euro area sovereign debt crisis around 2012.
That alone tells us how dramatically markets have repriced French fiscal risk in recent weeks.
Investors remain extremely uneasy over France’s fiscal trajectory. The government’s proposed 2027 budget, which includes around €43 billion in savings, still has to go through a deeply divided parliament ahead of next year’s presidential election.
Now, if the French-German yield spread stays elevated but other euro area spreads remain relatively contained, then this is very much a story that revolves around French fiscal repricing.
But if those other spreads start widening alongside it, then the conversation starts shifting from French fiscal risk towards broader euro area stress.
That is not to say that we haven’t seen some hints of that pressure already. The euro had fallen to a 17-month low against the dollar yesterday, with traders starting to question if France’s problems could spill over into the wider region.
Besides that, other European bond markets are also under strain and keeping on edge in the meantime. The spread between Italian and German 10-year bond yields has also widened to nearly 125 bps last week, before narrowing to around 110 bps now. That is still considerably higher from around 80 bps at the start of September, with the current spread being the widest in nearly 18 months.
With that in mind, I would argue that perhaps the market focus should not be too much on whether the French-German yield spread is 130, 140 or 150 bps on any particular day. Instead, the focus should really be more about the breadth of the move.
To put things more simply, France selling off on its own is largely a French fiscal problem. But France selling off while risk premiums rise across Europe, then that really starts becoming more of a euro area problem.
This article was written by Justin Low at investinglive.com.