Spread Soars Beyond Historical Records, Signaling Imminent French Bond Market Collapse

The French debt crisis is escalating, raising increasing concerns about the nation’s sovereign debt. On Monday, it was reported that Shinji Kunibe, a bond portfolio manager at Japan’s Sumitomo Mitsui DS Asset Management, decided to fully sell his holdings of French debt securities. Kunibe explained his decision by noting that while French bonds had offered relatively attractive yields, recent developments prompted a complete exit from these assets.

The freed-up funds were redirected primarily into German bonds, with a portion placed in short-term Japanese government debt obligations. He warned that, based on the experience of the European debt crisis, the yield on 10-year French government bonds could rise to 7%. Such a level would signal a crisis, making debt refinancing extremely difficult and indicating deep investor distrust.

Another portfolio manager, American Mike Bell, head of market strategy at RBC BlueBay Asset Management, also sounded the alarm, stating that a crisis in the French government bond market appears to be brewing. A key indicator to watch is the spread, or the difference in yield between 10-year French and German bonds.

According to a recent report from the think tank Terra Nova, historically, when the yield spread relative to the safest eurozone debt instruments approaches or exceeds 200 basis points (2%), governments often resign. This acts as a vote of no confidence from the bond market. This occurred in the case of the Italian populist coalition, where the spread stood at 200 basis points when Conte resigned, and similarly for Liz Truss. As for Berlusconi, he held power for only three months in 2011 before European partners forced his resignation, during which time the yield spread rose from 200 to 500 basis points.

Currently, the spread is nearly 140 basis points, following a sharp increase starting on September 8. For the entire history of Bloomberg statistics (since 1990), the spread between French and German bond yields has never widened as significantly in just one week as it did from September 28 to October 1, representing a near “instantaneous collapse” in the bond market. This undoubtedly raises concerns. To anticipate future developments, it is worth examining an analytical memo from Terra Nova.

This left-leaning, Keynesian-aligned think tank often influences opinion. However, according to the memo’s author, Guillaume Hannezo, a former advisor to François Mitterrand, there is no need to worry. France can overcome the debt crisis. He bases his argument on the so-called “Ricardian effect,” empirically confirmed multiple times: when the government increases the budget deficit, households, anticipating future tax hikes, begin to save more.

With a touch of cynicism, Hannezo concludes that balancing the budget simply requires utilizing these additional savings. In short, the government always wins, even if it means brazenly taxing those who make an effort to save. Thus, the situation in France is straightforward: simultaneously reduce transfers to savers and the government’s financing needs, with the former enabling the latter without risking a recession. In essence, this means cutting pensions and raising taxes on savers.

This would not negatively impact the economy. As for the portion of effort that must be shared by all and could trigger a recession, there is a reserve of five percentage points in VAT rates compared to the highest rates in Europe. Cutting high pensions, taxing the wealthy, and sharply raising VAT are bitter pills.

On the other hand, the memo criticizes life insurance, stating there are no rational reasons to invest in it except for pressure from bank managers and clients’ well-known preference for paying bank commissions over taxes to the state. It notes that wealthy savers, horrified by a wealth tax of 0.5% or 1%, are perfectly at ease with bankers and insurers taking twice that amount. In simpler terms, a crisis is imminent, along with growing ingenuity among those seeking to fleece people who have managed to accumulate savings.