Global Rates: Mixed themes in European rates – Euro area sovereign spreads and France, seasonality in DM rates, cross-currency basis update and UK rate markets

Francis Diamond (0:03)

Hi, and welcome to At Any Rate, JP. Morgan's Global Research Podcast Series, where we take a look at some of the drivers behind the biggest trends and themes across fixed income currencies and commodity markets.

I'm Francis Diamond, Head of European Rate Strategy at JPMorgan, and today I'm joined by several of my colleagues, Aditya Chordia, Khagendra Gupta, and Elisabetta Ferrara, to discuss recent dynamics in year-to-year solvent spreads, and in particular, France. Seasonality and DM rate markets, an update on cross-currency basis, and UK rate markets ahead of the budget. But I think to start with, there's clearly been a lot of focus on the substantial widening in solvent spreads in the year area. This week, focused a little bit on Italy, Spain, but particularly France, with credit curves flattening over the past couple of days.

We now have the 10-year France-Germany spread widening for over 75 to 80 basis points since early August. And yes, upcoming budget discussions around some fiscal uncertainty, these moves are looking pretty stark.

So Aditya, there's a lot of focus on these moves in year area of solvent spreads, as I mentioned, particularly France. How do you explain the recent widening and how French spreads now move too much, do you think?

Aditya Chordia (1:11)

So thanks, Francis. Yeah, like I said, I like it and I think everyone has noticed. Euro rates have had a very volatile week, and especially the intramuse spreads which are moving in quite large ranges or ranges being drawn more I think in this one direction which is just widening, especially France, the screens are just moving every time you blink. So yeah, a lot going on there.

If I just say anecdotally, what we have noticed is there's an ongoing large accretations of overweight carry exposures, mainly in the front end, which in our view explains the bare flattening of credit curves during the recent spread writing move. So a lot of recent moves in our view is more technical in nature, because in the last couple of weeks, not much fundamentally has changed in politics or fiscal, which would war in such large widening or even large spread writing, not just in France even wider. So there is a lot of technical factors at play.

I will just make sure I stress that at the starting. As we've been highlighting in our recent publications, widening pressures across inter-media spreads has been concentrated in weaker sovereign spreads over the past few weeks, while higher quality issuers have remained comparatively insulated. This in our view reflects like say resilient regional growth, which has been reinforced by the strong PMI we saw last week, the sharp rise in yields and higher volatility in rates. The yields are coming down, but we did have a significant round of sell-off in German yields before, and also the renewed caution on France, I mean expectation of choppy political news flow, which is the expectation it will stay this way, going into a presidential election early next year. Lastly, and as I said, the main factor, technical and positioning headwinds.

This week, the spread sensitivity of higher debt sovereigns to the level of yields even collapsed. At least till last week, yields are selling off and the spreads were widening. But this week around, we are seeing a rally in broader yields. The German yields are rallying a lot, but spreads are still widening, which again points towards the more technical nature of the move this week. In France, when we look at the sovereignist framework where we compare macro fundamentals across countries and rank them on the fundamental scale, what we notice is that France is now trading more than 40 basis points too wide on this framework. Historically, France used to trade 20 basis points expensive before 2024, but now it has been trading fair to small, cheap since 2024, but now it's trading more than 40 basis points too wide. Again, is there a level which goes too much? It's very hard to put a number. Just to give you a context, Italian spreads have traded on average 50 to 60 basis points too wide on this metrics. Between, let's say, the solving crisis and before the Maloney government came into power. Since the Maloney government came to power, this discount has declined quite a bit. But Italy has a 50 to 60 basis point. I'm not arguing anywhere that France should trade like Italy, because it's very hard to compare those two scenarios. But what I'm trying to say is that France can continue to trade on a cheaper side on the scale, given the fiscal and political challenges. But I think clearly near term the technical factors has moved it a bit too much.