Eurozone Bond Yields Edge Higher Amid French Political Uncertainty

Euro zone government bond yields saw a slight rise on Wednesday amid ongoing political uncertainty in France. The 10-year bond yield spread between France and Germany remained stable but elevated due to concerns over France’s fiscal position and potential election outcomes. Market sentiment remains fragile, with broader implications from U.S. Federal Reserve expectations also in play.

Euro zone government bond yields were slightly higher on Wednesday, while the risk premium that investors demand to hold French bonds was steady as attention remained on political uncertainty in France. The gap between France and Germany's 10-year yields stood at 73 basis points (bps), up less than 1 bp from the previous session, but below the 80 bps hit last week.

The spread has widened from under 50 bps since French President Emmanuel Macron called a snap election this month in response to a strong showing for far-right parties in the European Parliament election. With Marine Le Pen's National Rally leading in the polls but looking set to fall short of an outright majority, the risk of a hung parliament or far-right government has investors worried about France's debt path and fiscal situation.

"I don't think it's realistic to expect any meaningful tightening of French spreads in the run-up to the election," said Jussi Hiljanen, head of European rates strategy at SEB. "The spread might be a bit more stable here but still have some underlying widening bias."

The European Union said on Wednesday it wanted to start disciplinary budget steps against France, Italy, Belgium and other smaller EU countries over their excessive budget deficits, requiring them to reduce their shortfalls. Danske Bank's fixed income research director, Piet Haines Christiansen, did not expect this to be a surprise to the market, but said it could get "significant" market attention, given fragile sentiment in France.

France's 10-year bond yield was up 2 bps to 3.1391%. It had spiked as high as 3.338% last week. Bond yields move inversely with prices. Germany's 10-year bond yield, the euro zone's benchmark, stood at 2.396%, up 1 bp on the day but down almost 30 bps from a high of 2.678% reached last week.

"German bonds have received some support from the election turbulence and from the macro picture," SEB's Hiljanen said. "We have had softer U.S. data which overshadowed a bit more hawkish Federal Reserve."

On Tuesday, U.S. retail sales grew less than expected, reinforcing expectations that the Fed will begin lowering borrowing costs this year. The scale of the U.S. economy means global markets, including euro area bonds, and rate cut expectations for the European Central Bank, often move due to shifts in Fed expectations.

A significant number of economists polled by Reuters see the ECB cutting its deposit rate twice more this year, in September and December, following June's rate cut. Italy's 10-year yield, the benchmark for the euro zone's more indebted countries, was up 2.5 bps at 3.914%, pushing the spread between Italian and German 10-year yields to 150 bps.

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