French political risk is bubbling up once again. The 10 year OAT-Bund spread has been widening steadily in the past month and now sits at the top of its 52 week range while 10 year OAT yields are at their highest since 2008.
Facing ever higher borrowing costs, French Prime Minister Sébastien Lecornu chose this week to paint a picture.
With interest rates adding another €10bn per year to the €65bn per annum they already cost his administration, the French government must freeze all non-defence state spending at 2026 levels in its 2027 budget, due in the coming weeks.
Even with that measure, getting the budget passed is looking virtually impossible for Lecornu and his cabinet, given they have no governing majority and this year’s budget faces additional scrutiny ahead of the presidential election next year.
Intriguingly, all of this could be a positive for French covered bond issuers.
With French sovereign debt bearing the brunt of the worsening fiscal situation, French covered bonds have proved resilient with the aggregate French covered bond index currently trading 29bp through OATs, its tighest against the French sovereign since 2024.
Research from Barclays this week went so far as to say French covered bonds now “trade functionally independently of OATs” with the UK bank referencing analysis into what proportion of a move in the OAT-Bund spread passes through to the French covered bond-OAT basis. This year the ratio is 5% compared to 34% last year and 45% in 2024, the bank suggested.
Barclays also noted the divergence between French public sector covered bonds and French mortgage covered bonds, with the latter trading well inside the former since the start of last year.
Moody’s is set to review France’s Aa3 rating on October 23 with another downgrade a serious risk. But any such adjustment would have little or no effect on French covered bonds, most of which are themselves rated triple-A with unused uplift.
While the pending French political machinations should provide compelling viewing, investors may sleep easier with their cash housed in the relative safety of the nation's covered bonds.