European bond markets kicked off the week on a firmer note Monday, with investors bidding up the value of troubled French debt following a surprise move by Moody's Investors Service to keep the nation's final triple-A credit rating intact.
Moody's held its Aa3 rating, the weakest of its triple-A grades, in place on Friday after a review of the nation's debt metrics that coincided with a sharp slump in government bond prices tied to inflation pressures, electoral risks, and public disruptions linked to violent student protests.
However, the ratings company said its assessment is linked to an assumption that France passes "a deficit-reducing budget for 2027, while financing costs and social tensions will abate somewhat in the next few months."
Benchmark 10-year French government bonds, known as OATs, rallied around 10 basis points Monday to change hands at 4.958%, a level that still places them near the highest levels in two decades.
The extra yield, or spread, that investors demand to hold the debt compared to triple-A rate German bunds, the Eurozone's effective risk-free option, were pegged at 135 basis points, well shy of last week's peak near 177 basis points.
The Moody's decision is likely to only buy France a modest amount of time to steady its financial ship as investors look to Thursday's European Central Bank rate decision and plot the likely path of discussions for a budget agreement heading into next year's presidential elections.
"Having at least this one risk event out of the way might bring about some stabilization," said ING's regional head of America research Padhraic Garvey. "But any lasting relief will need positive news. A budget for 2027 with at least some semblance of fiscal consolidation would be a start, but might also have to wait until December."
France's minority government, led by Prime Minister Sébastien Lecornu, is looking to pass a budget for next year that includes around $60 billion in savings that will trip the nation's deficit to around 5%. Overall debt, however, is likely to top 120% of a weakening GDP, placing France behind only Italy on the Eurozone's list of highly indebted nations.
Those debt levels, as well as France's role in the broader European Union, are likely to be the central themes of next year's elections, which current polling suggests are being led by far-right leader, and longtime anti-Brussels advocate, Marine Le Pen.
Her closest rival, far-left leader Jean-Luc Melenchon, is also no fan of France's EU membership, and has openly advocated for France to "take the 18% [of French debt] held by the Bank of France and chuck it in the fire."
Such a move would place Paris squarely in opposition with Brussels, as EU rules forbid national central banks from financing federal government deficits.
"A significant and sustained fiscal effort will still be needed beyond the presidential elections of April and May 2027 to bring France's public finances onto stronger footing and stabilize a debt burden that will exceed 120% of GDP in 2027," Moody's warned.
"While we expect that the next president and government will seek to continue to narrow France's deficit, our baseline expectation is that they are unlikely to be able to implement rapid fiscal consolidation in light of social tensions, a political environment that is likely to remain fragmented and muted GDP growth," the group added. "As a result, the debt burden will continue to rise through the remainder of the decade."
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