Eurozone Spreads Widen on Political Uncertainty
Whenever folk start to talk about eurozone spreads, it never tends to be an especially good omen...
That's exactly what has happened over the last week or so, with participants again watching the OAT-Bund spread like hawks. For those unaware, this spread measures the difference in yield between that on 10-year Bunds (German government debt), and 10-year OATs (French government debt). With Bunds perceived to be the safest Govvies in the eurozone, the wider this spread, the greater the premium that investors are demanding for holding, in this case, French debt over that of Germany. Hence, the wider the spread, the 'riskier' said debt is perceived to be. Furthermore, wider spreads introduce greater fragmentation risk - i.e., the risk that ECB policy shifts are not transmitted equally to all of the bloc's member state economies.
The latest widening of the OAT-Bund spread, which briefly touched its widest level since 2012 last week, comes as France continues to struggle to pass a Budget, and as the far-right National Rally, led by Marine Le Pen, threatens to collapse the government over the affair. Clearly, this bout of political instability would be bad enough on its own, but it is perhaps more important than usual at this juncture, as French PM Michel Barnier (yes, that one from the Brexit days) attempts to cut a budget deficit that is on a path to balloon north of 6% of GDP, double the ostensible 3% EU limit.
Speaking of the eurozone, this upheaval is just the latest negative catalyst with which the bloc must grapple. Germany is in political turmoil ahead of elections next February; the bloc's manufacturing sector is in what can only be described as a structural depression; geopolitical tensions in the Middle East and Ukraine continue to present significant risks; the lack of any notable recovery in China poses headwinds, particularly to the luxury sector; and, the threat of trade tariffs in a second Trump Administration continues to loom large.
While that is a very long, and very negative, laundry list, I would argue that a significant degree of those negative factors are already in the price. We might, therefore, be inching towards a point of 'peak pessimism' towards the common currency, which could open the door to a modest short-term recovery.
Michael Brown | Senior Research Strategist at Pepperstone
Assistant Vice President, Wealth Management Associate
2 个月Very helpful
Director at Oku Markets | Business Currency Management | HNW Private Client FX | AFC Wimbledon Sponsor
2 个月a very interesting read, as always!