French government bonds (OATs) have been under pressure for much of 2024 amid fears that a higher-than-expected fiscal deficit would significantly increase the issuance of debt. Those fears were confirmed with the 10 October budget and OATs are facing renewed scrutiny from investors with a potential rating downgrade on the horizon.
The first bullet was narrowly dodged on Friday when Fitch left its AA- rating on France unchanged but downgraded its outlook on the sovereign to ‘negative’ from ‘stable’. Fitch said the negative outlook reflects its expectation that wider fiscal deficits will lead to a ‘steep rise’ in government debt to 118.5% of gross domestic product by 2028. Fitch also expects the budget deficit to widen to 6.1%, significantly exceeding the 5.1% target it forecast in April. The rating agency added that ‘high political fragmentation and a minority government complicate France’s ability to deliver on sustainable fiscal consolidation policies’.
To cover the higher deficit, France has set out a funding plan comprising a record gross issuance of €300bn of OATs in 2025 compared to €285bn of issuance this year and €270bn in 2023.
In a note on Monday, analysts at Rabobank said that based on Fitch’s analysis, the credit rating agency ‘could have easily justified a downgrade’, which was the analysts’ expectation. But rather than breathe a sigh of relief, all eyes will now turn to 25 October when it will be Moody’s turn to present their verdict on France’s credit rating, which it currently holds at AA with a stable outlook.
Investors and market participants believe a downgrade by Moody’s will have the biggest repercussions for the wider European public sector bond market. Not only will a downgrade directly impact OATs, but also French agencies and sub-sovereigns, such as CADES and Unédic who hold an implicit guarantee from the French government.
Analysts at DZ Bank argue that a rating cut by Moody’s will also impact European public sector issuers including the EU, whose credit rating by Moody’s is ‘particularly sensitive to rating changes for countries with a rating of at least Aa2’. Fitch and S&P only consider the ratings of Germany and the Netherlands to be most significant for the EU’s credit rating.
Meanwhile, the European Financial Stability Facility’s credit rating is based on the guarantees of the euro area member states. A downgrade to France as the second largest guarantor would also have an impact to EFSF’s credit ratings according to Fitch and S&P’s assessments. However, Moody’s does not view individual rating changes as a direct impact to EFSF’s rating.
From a trading perspective, OATs have held up well in recent weeks with the yield on France’s 10-year trading at 3.04% and the 10-year OAT/Bund spread at 76.7 basis points on Monday. But these numbers are slightly arbitrary in that France already trades and behaves like single-A or even BBB sovereign. For example, France trades above Belgium (double-A), whose 10-year government bond was yielding 2.88% on Monday, and is rather more akin to the likes of Slovenia (single-A) and Spain (BBB) whose 10-year bonds were yielding 3.01% and 3.02%, respectively. This year, the yield on France’s 10-year government bonds traded above Spain’s for the first time since the 2008 financial crisis in a further sign of investors’ concerns with France’s economic and political risks.
In May 2024, S&P was the first of three major credit rating agencies to downgrade France this year when it pushed the sovereign from AA to AA- based on fears of an increase in government debt and a widening budget deficit. That decision was seen then as more of a graze than a wound ahead of the legislative elections and budget. Now it seems that France could be left with a bruise for a while yet.
OMFIF’s Sovereign Debt Institute will be convening a group of French agencies and sub-sovereigns, as well as those from Germany and across Europe in a forum taking place in Frankfurt on 12 November. Click here for more details and to secure your place.
Burhan Khadbai is Head of Content, Sovereign Debt Institute at OMFIF.
