French Bond Yields Drop Amid Post-Election Uncertainty

French government bond yields fell to their lowest levels in two weeks following a hung parliament outcome in Sunday's election. The decrease eased fears of a far right victory, although factors like weak U.S. economic data and potential Federal Reserve rate cuts also contributed to the decline.

French government bond yields fell to their lowest level in two weeks on Monday, after Sunday's election resulted in a hung parliament with a surprisingly strong showing by the left, allaying fears of a far right victory. French yields traded at their lowest premium to German debt in almost a month before reversing some of the fall. The so-called spread hit its highest since the euro zone crisis in 2012 in late June as investors worried about a possible jump in government spending under a potential far right prime minister.

The yield on France's benchmark 10-year bond fell to its lowest since June 26 at 3.166% and was last down 4 basis points (bps) at 3.174%. Yields fall as prices rise. German 10-year debt was down 1 bp at 2.517%, leaving the gap with French yields - which reflects the premium investors demand to hold French debt rather than Bunds - 2 bps narrower at 66 bps.

That spread briefly hit a session low of 63.7 bps, the smallest since June 13. Jussi Hiljanen, head of rates strategy at lender SEB, said yields had been trending lower in recent days on the back of weak U.S. economic data, which has bolstered hopes that the Federal Reserve will cut interest rates this year.

Given the size and importance of the U.S. economy and dollar, Fed decisions reverberate through global financial markets. The leftist New Popular Front emerged as the dominant force in the National Assembly after Sunday's election. Yet no single grouping secured a majority, triggering tricky negotiations that could result in an unwieldy coalition or a minority government.

President Emmanuel Macron's alliance came in second place, with the far right National Rally ending third after leading in the polls for weeks. "The left wing alliance is not seen as business friendly and should command less faith in prudent budget management," said Peter Schaffrik, global macro strategist at RBC Capital Markets.

"However, the lack of a clear majority in the Assembly should blunt any spending plans for the time being and act as a cushion for spread widening." Elsewhere, Italian 10-year yields fell 5 bps to 3.891%. That left the Italian-German yield gap 3 bps narrower at 137 bps, around its lowest in a month.

Bond markets awaited U.S. consumer price index inflation data on Thursday, which will influence the U.S. Federal Reserve's upcoming interest rate decisions. Investors will also be listening closely when Fed chair Jerome Powell testifies before Congress on Tuesday.

(With inputs from agencies.)