French Spreads Retreat as Panic Over Elections Starts to Ebb

(Bloomberg) -- Spreads on France’s bonds retreated from the highest level in over a decade, in a sign investors are becoming more sanguine about potential disruption from a snap parliamentary election that begins Sunday.

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The nation’s 10-year yield spread over Germany has retreated four basis points to 76bps since Friday, the biggest two-day drop in over a year. The risk premium had been surging since President Emmanuel Macron called a snap election two weeks ago.

Jordan Bardella, the leader of the National Rally party which is leading the polls, sought to calm investors Monday with assurances that he will not upend the country’s finances if his party wins an absolute majority after two rounds of voting ending July 7. Even before his comments, big investors including Vanguard Group Inc. had said they would consider buying French bonds if the spread continued to widen.

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The National Rally “has indicated to businesses and market participants that it will respect the European Union’s fiscal rules and that it understands the need to govern in a conciliatory manner,” Nomura International Plc strategists including Andrzej Szczepaniak wrote in a note. A leftist alliance called the New Popular Front, which is second in the polls, is now “more feared” than the right-wing party, the analysts said.

While Le Pen’s party is sticking to a plan to immediately cut sales taxes on energy and fuel, it has said it will postpone other key spending pledges to a later phase if it leads the next government. Bardella has said the longer term feasibility of much of its program would depend first on an audit of public finances.

France’s fiscal situation was already weighing on investor sentiment before the snap election was announced, with Macron’s current government forced to revise long-term plans to plug holes in the budget earlier this year. S&P Global Ratings downgraded France last month and the EU has since put the country in a special procedure for member states with excessive deficits.

Benjamin Schroeder, a senior rates strategist at ING Bank said he doesn’t see the vote offering “an easy fix to the deteriorating government finances.”

“From a tactical perspective, we therefore remain cautious about buying into the French bond spread widening since the catalysts of a substantial re-tightening are hard to envisage,” he added.

The National Rally estimates that the cut to energy sales taxes would cost the state €7 billion ($7.5 billion) this year in lost revenues and €12 billion next year. That would be financed by measures including closing tax exemptions for shipping companies and cutting spending on immigration and transfers to the EU, according to the party.

The New Popular Front has stuck to much more ambitious pledges that it says would ramp up over time to reach €150 billion a year in additional outlays by 2027. Such measures would be financed by equivalent tax increases on business, finance and the wealthy, according to its manifesto. Polls show that the leftist group, which spans moderate social democrats to the far-left France Unbowed, is less likely to get an absolute majority.

(Add comments on election manifestos, fiscal situation from sixth paragraph)

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