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OAT: Tighter vs Bunds Alongside Peers, But Ratings Action Reaffirms Fiscal Risks

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The 10-year OAT/Bund spread has tightened alongside EGB peers this morning (1.5bps narrower at 72bps), with Bunds leading the selloff in core EGBs amid prospects for increased German defence and infrastructure spending. However, meaningful tightening below the 70bps handle may still be limited given domestic fiscal/political risks, not least following S&P’s outlook downgrade on Friday. 

  • S&P revised France’s Outlook to Negative from Stable (rating affirmed at AA-), reflecting “rising government debt amid weak political consensus for tackling France's large underlying budget deficits, against a backdrop of more uncertain economic growth prospects”.
  • Ongoing negotiations around pension reform (which was an important concession made by PM Bayrou in trying to gain support from the Socialist party) presents a key risk to the outlook: “If the government dilutes the 2023 pension reforms significantly, this could create downward pressure on the ratings by increasing imbalances in France's social security system, a key component of general government finances”.
  • This morning, Finance Minister Lombard and Budget Minister Montchalin have announced new processes to avoid significant forecast errors in key fiscal targets. For more, see here.
  • Despite the obvious fiscal constraints France faces, Lombard nonetheless noted the need to increase defence spending in the current geopolitical environment: “We will need to find room for manoeuvre because it’s clear that the new world balance requires an increased effort in defence to preserve peace”. 

 

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The 10-year OAT/Bund spread has tightened alongside EGB peers this morning (1.5bps narrower at 72bps), with Bunds leading the selloff in core EGBs amid prospects for increased German defence and infrastructure spending. However, meaningful tightening below the 70bps handle may still be limited given domestic fiscal/political risks, not least following S&P’s outlook downgrade on Friday. 

  • S&P revised France’s Outlook to Negative from Stable (rating affirmed at AA-), reflecting “rising government debt amid weak political consensus for tackling France's large underlying budget deficits, against a backdrop of more uncertain economic growth prospects”.
  • Ongoing negotiations around pension reform (which was an important concession made by PM Bayrou in trying to gain support from the Socialist party) presents a key risk to the outlook: “If the government dilutes the 2023 pension reforms significantly, this could create downward pressure on the ratings by increasing imbalances in France's social security system, a key component of general government finances”.
  • This morning, Finance Minister Lombard and Budget Minister Montchalin have announced new processes to avoid significant forecast errors in key fiscal targets. For more, see here.
  • Despite the obvious fiscal constraints France faces, Lombard nonetheless noted the need to increase defence spending in the current geopolitical environment: “We will need to find room for manoeuvre because it’s clear that the new world balance requires an increased effort in defence to preserve peace”.