French bond investors on edge after tax-raising budget

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Bond fund managers say France’s borrowing costs are likely to remain elevated after a proposed budget that they argue has not dispelled anxiety about the country’s degraded public finances and political uncertainty.

On Thursday, French prime minister Michel Barnier unveiled €60bn of spending cuts and tax increases, saying the “credibility of the French signature must be preserved”. France is on track to have a deficit this year of more than 6 per cent of national output, far overshooting its target, while its overall debt burden to GDP is the third worst in the Eurozone after Greece and Italy.

Investor concerns about France’s debt load have contributed to a sell-off in France’s long-term debt this year that has taken its 10-year yield to more than 3 per cent, and above Spain’s for the first time since the 2008 financial crisis.

The extra interest rate demanded by its investors compared with Germany’s, the Eurozone benchmark, is at 0.77 percentage points, close to the 12-year high reached in the run-up to this summer’s parliamentary election.

“I’m sure many bondholders are scratching their heads,” said Kevin Thozet, an investment committee member at French fund manager Carmignac, pointing to what he saw as the budget’s “generous” assumptions around economic growth and productivity gains.

He also highlighted the political risk involved in passing the budget since parliament could bring down Barnier’s government, as well as the need for solid economic performance over the coming months if Paris is to meet growth forecasts. 

“If one of those pieces of the puzzle were to move in the wrong direction, that could move those spreads higher,” Thozet said.

Other bond investors also said France’s unstable government was deterring buyers. 

Investors felt “relief that a government was formed, led by Barnier [and] able to put together a budget in a timely fashion, but the market is under no illusions as to the underlying instability within French politics,” said Royal London Asset Management’s Gareth Hill. 

He said the “spectre” of some upcoming credit rating reviews for French sovereign debt, and the challenges of getting “tough” budgetary decisions through parliament were weighing on bond prices. 

France expects to issue €300bn in government debt, adjusted for buybacks, in 2025. Barclays analysts said this was slightly below its forecast, so a positive surprise, but added “how credible the government’s deficit estimates are will remain an open question”.

“Bottom line, [French bonds] are still not floating our boat,” they said.

Mark Dowding, chief investment officer at RBC BlueBay Asset Management, said investors “probably see this as an OK outcome for now”, though the “biggest risk” in France remained its political uncertainty. 

BlueBay, he said, had booked profits on its bet against French 10-year bonds when the spread above Germany’s recently hit 0.8 percentage points, but it would put the bet on again if spreads drifted sufficiently lower.

Ben Lord, a fund manager at M&G Investments, said the manager was also “concerned by the continuing fiscal looseness in France” despite the announced measures. “There is still uncertainty around how effective these will be, especially on the tax side of things,” he added.