EGBS: OATS Continue To Underperform SPGBs & PGBs

French 10s continue to underperform on the SPGB/OAT/PGB fly, with that structure moving further below 0bp, closing at fresh cycle lows in recent sessions.

• Markets seem to have found a rough area of “fair value” in the Bund/OAT spread, at least for now, with that differential closing around 70bp for more than 2 weeks.
• Several factors make it hard to argue for notable French outperformance in the short-term:
• Relative fiscal outlooks, with France facing greater challenges on that front.
• Cutting cycles at the major central banks, which typically benefit ‘carry plays’ in SPGBs & PGBs more than OATs
• The move lower in EUR swaption vol.
• France has been tasked with meaningful fiscal reform. Timelines for the already ambitious goals have been further pushed back by PM Barnier’s apparent lack of progress in forming a cabinet, promoting the latest leg of OAT underperformance.
• Elsewhere, RN leader le Pen has suggested that fresh elections will need to be held within a year, while unveiling an economic manifesto that would result in business tax cuts and fiscal measures favouring French citizens.
• That adds a further layer of complication into fiscal and political negotiations, even though RN has not been invited to form a government.
• The upcoming run of French sovereign credit rating reviews (starting with Morningstar DBRS this Friday) provide further event risk.

Fig. 1: 10-Year Spain/France/Portugal Butterfly (bp)