Euro zone bond yields decline and the spread between French and German bonds narrows

Euro zone bond yields fell on Tuesday, and the spread between French and German 10-year bond yields narrowed again from the highest level recorded last Friday, at a time when investors assessed whether the recent increase in the risk premium on French bonds had gone too far too quickly.

French borrowing costs have risen sharply in recent weeks, and the yield differential with Germany widened on Friday to its widest level since the euro zone debt crisis in 2011, amid concerns about the deteriorating financial situation in France ahead of the presidential elections scheduled for next year, according to Reuters.

The sell-off in the bond market calmed slightly this week, as the spread, which measures the risk premium required by investors to hold French debt rather than German debt, fell to 135 basis points. On Friday, the spread reached its highest level in 15 years at 158 ​​basis points.

France is scheduled to officially present its draft budget for 2027 on Tuesday, while far-right presidential candidate Marine Le Pen is preparing to present plans to reduce government spending by 25 billion euros ($28 billion) annually.

“France has never shown a consistent commitment to fiscal consolidation,” said Guillermo Felices, chief global fixed income investment strategist at BGIM. “This is what needs to happen now.”

He added: “Whoever leads France will somehow have to reach common ground within the French parliament to achieve financial consolidation that goes far beyond anything we have seen from France before.”

French Finance Minister Roland Lescure said that bond market turmoil has not yet reached a stage that requires thinking about using the monetary policy tools possessed by the European Central Bank to stabilize borrowing costs.

The French 10-year bond yield fell 7 basis points to 4.792 percent on Tuesday, while the 10-year German bond yield fell 5 basis points to 3.439 percent.

Expectations of a rate hike from the European Central Bank decline

The turmoil in the bond market prompted investors to lower their expectations for an interest rate hike by the European Central Bank.

Markets are currently pricing in an 80 percent chance of another rate hike before the end of the year. Markets had previously expected at least three additional hikes by the March meeting, but they are now fully pricing in one hike, with a probability of about 80 percent for a second hike.

European Central Bank chief economist Philip Lane said on Monday that the recent rise in borrowing costs represents one of the factors that may put pressure on the economy by reducing demand, which reduces the amount of measures the central bank needs to take to contain price pressures.

“In general, most ECB members appear to have become less hawkish, but they are significantly reducing their comments on bond markets,” said Christoph Rieger, head of interest rates and credit research at Commerzbank.

The two-year German bond yield, which is highly sensitive to changes in monetary policy expectations, fell two basis points to 3.037 percent.

European stocks rose to near their highest levels on Tuesday, supported by strong gains in Genmab shares, which led the rise in health care stocks, while euro zone bond yields fell after a rally driven by financial and inflationary fears.

The European Stoxx 600 index rose 0.8 percent to 638.41 points by 07:27 GMT, heading towards recording a third consecutive session of gains, according to Reuters.

Genmab stock jumped 7.6 percent, topping the gains of the STOXX 600 index, after an advanced study showed that the leukemia treatment combination developed by the Danish biotechnology company in cooperation with the American pharmaceutical company AbbVie reduced the risk of disease progression or death.

The broader health care sector index rose 1.6 percent.

Later Tuesday, attention will turn to retail sales data in the euro zone and the Standard & Poor's Global survey of the private sector in Britain, which may provide indications of the levels of consumer spending in the region and the activity of the British economy.

The euro stabilized near its lowest level in 17 months, affected by political uncertainty after Spanish Prime Minister Pedro Sanchez called, on Monday, for early elections.

In France, the government is seeking to pass the unpopular 2027 budget to reduce the budget deficit, which led to a widespread selling wave in the bond market.

However, euro zone bond yields fell after last week touching multi-decade highs.

In other stocks, the Italian company Technoprop rose by 2.3 percent, after JP Morgan began covering the stock with an “overweight” recommendation.