Skip to content
Themes

Theme · past 4 weeksEuro area

France’s spread test: OATs above Italy, no ECB backstop

France now borrows above Italy and the ECB won’t backstop it, so the OAT–Bund spread trades on French politics and ratings.

What it did to the curve

Front end

Yields mixed

2-year

Long end

Yields mixed

10–30-year

Curve

mixed

long minus short

A spread story, not a curve story: the OAT–Bund 10-year spread reached about 147–152bp on 2 Oct, the widest since late 2011, then eased to about 137bp by 16 Oct.

OAT–Bund 10-year

137.4bp

downfrom about 147–152bp

16 Oct against 2 Oct, when the spread was the widest since late 2011.

OAT 10-year

about 4.79%

downfrom 4.924%

16 Oct against 1 Oct, when it hit its highest since 2002.

France over Italy, 10-year

about +22bp

1 Oct, derived from 4.924% and 4.708%: markets priced France as riskier than Italy.

French debt, next year

about 122% of GDP

upfrom 119.3%

One projection; Moody’s reviews France on 23 Oct, the next catalyst for the spread.

What happened

France has become the euro area’s pressure point. Its 10-year OAT hit a post-2008 peak on 31 Aug, and on 24 Sep a budget battle raised fears of another government collapse. On 1 Oct the OAT yielded 4.924%, the highest since 2002 and about 22bp above Italy. On 2 Oct the OAT–Bund 10-year spread reached about 150bp, the widest since late 2011.

This is a spread story, not a curve story. The OAT–Bund spread is the investors charge France over Germany, the euro area’s benchmark. Both bonds answer to the same ECB, so the spread strips out the rate expectations that move both.

The premium looks France-specific, not euro-wide . TD Economics noted that Italy’s yield rose about 132bp in the sell-off against about 150bp for France. France’s , the cost of insuring its debt, also trades above Italy’s.

No backstop is coming. The IMF chief warned France over its finances on 7 Oct, and on 14 Oct Lagarde ruled out ECB support: France must fix its finances itself. French bonds barely reacted, and by 16 Oct the spread had eased to 137.4bp. The OAT yielded about 4.79% and the Bund 3.42%.

The spread also feeds back into policy. On 9 Oct ABN AMRO said rising French yields and tighter financial conditions had helped dial back pricing for an ECB hike in October. The next tests are Moody’s review of France on 23 Oct and the ECB decision on 29 Oct.

Timeline

  1. · Euro area

    French budget battle raises fears of another government collapse

  2. · Euro area

    OAT 10-year hits 4.924%, the highest since 2002 and about 22bp above Italy’s 4.708%

  3. · Euro area

    OAT–Bund spread goes above 150bp, the widest since late 2011

  4. · Euro area

    The IMF chief warns France over its public finances

  5. · Euro area

    ABN AMRO: rising French yields helped dial back pricing for an October ECB hike

  6. · Euro area

    Lagarde rules out an ECB backstop for French debt; French bonds barely react

  7. · Euro area

    OAT–Bund spread at 137.4bp, with the OAT about 4.79% and the Bund at 3.42%

What could change it

Base case

The spread stays wide while the budget fight goes on: France keeps trading above Italy, the ECB stays out, and the moves come from ratings and politics.

Watch: Moody’s on France, 23 Oct · ECB, 29 Oct

Widening risk

A Moody’s downgrade or a renewed threat to the government sends the spread back towards its 2 Oct high above 150bp. With no ECB backstop, there is no buyer of last resort to cap it.

Watch: Moody’s on France, 23 Oct · ECB, 29 Oct

Relief rally

Moody’s leaves the rating alone and the budget fight cools. The spread keeps easing from 137.4bp and France’s gap to Italy narrows.

Watch: Moody’s on France, 23 Oct · ECB, 29 Oct

How desks express it

OAT–Bund 10-year widener into Moody’s

Spread

Sell 10y OATs, buy 10y Bunds (DV01-neutral)

With no ECB backstop and a France-specific premium, the 23 Oct ratings review is a catalyst skewed towards a wider spread.

  1. 1

    Lagarde ruled out a backstop on 14 Oct, so there is no policy floor under OATs.

  2. 2

    TD’s evidence says the premium is France’s own: French yields rose about 150bp against 132bp for Italy, with French CDS above Italy’s.

  3. 3

    The spread has eased from about 147–152bp to 137.4bp, so the position is not chasing the peak, and debt is projected near 122% of GDP.

Wrong if: Moody’s leaves France unchanged on 23 Oct and relief compresses the spread further; it has already eased from about 147–152bp to 137.4bp in two weeks without any ECB help.

OAT vs BTP 10-year

Cross-market

Sell 10y OATs, buy 10y BTPs (DV01-neutral)

Isolate the France-specific premium by hedging the euro-wide moves that hit France and Italy alike against Bunds.

  1. 1

    An OAT–Bund position also moves on euro-wide risk and ECB pricing; pairing France with Italy nets much of that out.

  2. 2

    France already traded about 22bp above Italy on 1 Oct (4.924% against 4.708%), with French CDS above Italian.

  3. 3

    If French politics and ratings stay the story, OATs keep underperforming BTPs.

Wrong if: Italy can widen fast too: BTP–Bund touched 131bp intraday on 2 Oct before closing at 114.6bp. A broad periphery sell-off, or a benign Moody’s outcome for France on 23 Oct, would hurt the trade.

Educational expressions of the theme — how a desk might position, not advice.

Test yourself

Finishing the quiz adds this theme’s key facts to your review deck.

The stories behind it

Sources