French debt outperforms on easing budget jitters

By Alun John

LONDON, Jan 26 (Reuters) - French government bonds outperformed euro zone peers on Monday, the premium required to hold French debt over German falling to its smallest since June 2024 as investors broadly welcomed the government's moves to push the 2026 budget through the legislature.

The yield on France's 10-year OAT government bond dropped more than 6 basis points to 3.43%, its lowest since late November. FR10YT=RR

Germany's 10-year yield was down almost 4 bps at 2.87% DE10YT=RR and that left the gap between the two at close to 56 bps, its lowest since the June 2024 French legislative elections. DE10FR10=RR

That spread, reflecting the greater yield investors require to hold French debt over German, has been elevated for the past two years as successive French governments grappled to deliver a deficit-taming finance bill that would pass in the lower house, where no party has a working majority.

But it has been narrowing sharply this month, dropping from around 70 bps at the start of January, and falling nearly 4 bps on Friday, and a further 3 on Monday.

Prime Minister Sebastien Lecornu's government survived two votes of no-confidence in parliament on Friday over its decision to ram through the income part of the 2026 budget without giving the National Assembly the final say.

"A large portion of the idiosyncratic premium in OAT has been unwound," said analysts at Goldman Sachs in a note.

French yields have also dropped back below Italy's, albeit only by a couple of basis points. IT10FR10=RR

France on Monday sold close to 8 billion euros in Treasury bills.

TIGHT SPREADS

It's not just Franco-German spreads that are narrow.

Goldman also noted that European spreads in general only widened slightly last week, even as bond markets globally digested substantial volatility in Japanese government bonds and geopolitical and trade tensions.

At times of stress, the gap between safe-haven German government bond yields and those of other Euro zone yields often rises. But the gap between German and Italian yields remains tight at 58 bps. DE10IT10=RR

That appears partly due to greater investor confidence in once-stressed southern European economies, but also because of a gradual shift in attitudes to German debt.

"In contrast to April 2025 (Trump tariff shock), (German) Bunds have not performed to the same extent ... one reason for this is that any further rise in geopolitical risk would only intensify the urgency for Europe — and Germany in particular — to use fiscal policy in response to these challenges," Goldman said.

More fiscal spending would likely require more bond issuance, and this greater supply of bonds would send yields higher.

Yields on shorter-dated debt fell slightly less than on longer ones. Germany's 2-year yield dropped close to 2 bps to 2.11% and France's dropped around 3 bps to 2.2%. DE2YT=RR, FR2YT=RR