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[MARKET ANALYSIS] OATs lag somewhat after the suspension of Fridays budget debate, what next?

OATs are underperforming relative to Bunds today, likely due to the French government suspending the budget debate, which postpones any immediate resolution on fiscal policy.

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[MARKET ANALYSIS] OATs lag somewhat after the suspension of Fridays budget debate, what next?

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  • OATs marginally underperform EGB peers, OATs -16 ticks at a 121.12 low vs downside of c. five ticks for Bunds at the moment. OAT-Bund 10r yield spread has opened slightly wider today at c. 68bps vs the 67bps close from Thursday, but remains shy of the 72bps YTD peak.
  • Slight underperformance that is likely a function of the French Government electing to suspend the National Assembly budget debate last night, meaning that the deliberations of the budget and likely conclusion of it will not occur today. As such, the pencilled-in date of a Monday vote on the revenue draft is off the table.
  • A decision taken by PM Lecornu, while pertinent, isn’t a total surprise given the tone of reports in recent sessions on the use of an alternative process to pass the bill and avoid a formal vote on it.
  • Politico sources report that Lecornu will on Friday be putting forward “proposals for changes to the initial draft”, changes designed to form a compromise between the centrist bloc, Socialist Party (PS) and Les Republicans (LR).
  • The two options now, broadly speaking, available to Lecornu are: an executive order/Ordinance/decree (Article 47.3) to pass the revenue bill with agreed amendments or the use of Article 49.3. An executive order means the budget remains even if the government is then subject to and defeated by a no-confidence motion. While Article 49.3 gives the Assembly an opportunity to examine the text and then decide on whether to put forward no-confidence motion(s), a process Politico argues is the least bad option available to Lecornu.
  • Credit Agricole wrote, prior to the suspension of debate, that Article 47.3 would be the most favourable scenario for public finances and result in a deficit of c. 4.9% for 2026. As a reminder, ECB’s Villeroy said to BFMTV that France would be in the “red zone” with a deficit above 5%. On Article 49.3, Credit Ag. thought that was the most likely scenario with over a 50% chance of it occurring, such an outcome would lead to a deficit between 5.1-5.2% of GDP.
  • Either way, the passage of the budget would be a positive in the sense that it eliminates some immediate risk. But, the market reaction will likely be determined by whether the budget deficit is above, at or below the key 5% mark. The deficit level will be determined by which measure Lecornu selects and what compromises end up being made to get the Socialists on board, particularly under the Article 49.3 scenario.
Context

This situation introduces uncertainty regarding the budget deficit target moving forward, particularly whether it exceeds the critical 5% threshold, which could impact investor sentiment and the wider fixed income market, especially in relation to ECB policy.

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