French 10-year bond yields are climbing ever higher, showing a mounting concern for the country’s finances. But does the current pricing spell trouble for the country’s future debt servicing?
According to the cost of servicing their debt, Cyprus, Spain and Croatia appear to be less risky investments in the bond market, than Europe’s second-biggest economy France.
The Eurozone sovereign bond market has been going through a transformation over the last year.
“Generally speaking, there’s been a lot of decline in yields across the euro area”, said Frank Gill, Managing Director and EMEA Sovereign Specialist at S&P Global Ratings to Euronews Business, adding that “the big exception is France”.
Some of the biggest surprises came from the bond market of the so-called periphery countries in the bloc, that struggled with unsustainable debts right after the financial crisis in 2008, including Portugal, Spain and Greece. Nowadays, most of them have to pay less to service their debts than the long-time favourite France.
One of the reasons is that these countries have put their debt on a sustainable path, with a backdrop of low inflation and high growth.
“Some of these countries with large tourism sectors which have been posting very high growth rates, very strong labour markets, and they are operating budgetary surpluses, including Portugal, Greece, even smaller economies like Cyprus”, said Gill. “They’re paying down debt. So the the absolute amount of debt in the market is declining. And I think that explains why, the ten-year yield of Greece declined over the last year by 0.5%.”
This trend is probably going to continue in 2025. “I think if these countries continue to post budgetary surpluses, meaning their overall level of debt is declining and is declining very rapidly over GDP because GDP is increasing quickly, then I think you will continue to see a convergence of their yields towards German yields”, said Gill.
How did France lose some of the investors’ confidence?
Europe’s second-biggest economy kept drawing unwanted attention this year, with the bubbling political turmoil, the last chapter of which led to the country concluding the year without a valid new budget for 2025.
For now, a special law allows public services to pay salaries and collect taxes, otherwise, the government needs to comply with the 2024 budgetary ceiling, until a new budget is approved.
Consequently, investors expect that the French deficit will remain around where it is in 2024, a bit more than 6% of the GDP. To finance that, the country will need to keep borrowing from the market, swelling further its debt which is already 112% of the GDP.
In the short term, the uncertainty triggered by the lack of clear fiscal policy and plans to put the debt on a sustainable path, may not let the currently elevated yields go down quickly in 2025.
“I definitely think there could be volatility in the French OAT market [the French bonds are called OATs which stands for Obligations Assimilables du Tresor] next year depending on what the 2025 budget eventually looks like, assuming there will be a budget finalised early next year”, said Gill.
He added that the country has a very significant deficit. “The debt to GDP path, as we project, is going to continue to increase between now and 2027 without much more significant adjustments.”
However, France’s 10-year bond yields have climbed to 3.05% after credit rating agency Moody’s downgraded the country’s debt on 14 December, and increased ever further since, “the actual cost for France to borrow hasn’t changed that much since December of last year”, said Gill, adding that “last year in December, their borrowing costs were around 2.75%, 2.8% on ten-year maturity”.
The cost of servicing France’s debt is also fuelled by investors’ concerns about who holds it. “Slightly over 50% of French debt is held by non-residents”, said Gill, adding that “there’s maybe some concern that non-residents might reduce their holdings of French bonds, which would mean that local banks and domestic creditors would have to absorb more supply, and that would likely lead to a repricing higher”.
Why political turmoil in Europe’s two biggest economies will not fundamentally shake the bond markets?
Meanwhile, Germany is also going through political turmoil with elevated uncertainty as the government lost a no-confidence vote recently and snap elections are to be held on 23 February 2025. Meanwhile, the country’s economy is shrinking.
Yet, 10-year German yields are comfortably sitting around 2.36% at the time of writing this article.
“I don’t think there are significant credit risks for Germany”, reassured Gill. “We would argue that German debt to GDP is actually fairly modest. They have very significant fiscal space and the economy as a whole is running huge excess savings.” He is also expecting Germany to relax its fiscal policy in order to stimulate growth.
“I think the market is looking at the policy of the incoming government. So they’ll be focusing on the election. What are they proposing in terms of budgetary policy, and budgetary stimulus? Will there be any specific industrial policies which require public subsidies? Anything that implies more supply of debt in two years or three years or four years?”
France and Germany are very wealthy economies which are generating huge domestic savings.
“France is also a very liquid system. The banks are extremely liquid. Banks don’t really have very large exposure to the sovereign. So I think while there are definitely medium-term challenges, fiscal challenges, political challenges, and growth challenges in both Germany and France. Their capacity to self-finance is extremely comfortable”, said Gill.
