Moody’s spares France downgrade as bond yields surge

France's borrowing costs climbed to levels last seen in the early 2000s this week. The country's debt risk premium over Germany reached a high not seen since the euro zone sovereign debt crisis, as budget gridlock and street protests weighed on investors. On Friday evening, Moody's ↘ 1.55% held France's Aa3 rating with a negative outlook rather than delivering the downgrade many analysts had expected. The agency said its view assumes that France will pass a 2027 budget that reduces the deficit and that financing costs and social tensions will ease, according to Dow Jones via Morningstar.uk.finance.yahoo.com

A week of records

The 10-year French yield rose above 5% on Wednesday for the first time since 2002 and was still trading above that level on Friday, Euronews reported via Yahoo Finance. On Thursday it touched 5.1415%, its highest since July 2002, and the spread over German Bunds widened to 177.7 basis points, the most since November 2011, according to Reuters reporting carried by StockWatch. Also on Thursday, five-year credit default swaps on French debt rose above 100 basis points for the first time since October 2012, Euronews noted.uk.finance.yahoo.com+1

French yields eased somewhat on Friday but were still headed for their biggest weekly increase since late May, the Economic Times reported. The euro also fell against the dollar, EUR/USD, as the government prepared to deploy 70,000 police for Saturday's protests, Reuters said. The 2027 budget includes €43 billion in spending cuts and revenue measures, but the government has no majority to pass it. Unions have called for a large mobilisation on November 5, Euronews reported.centraloregondaily.com+2

Contagion and the ECB

"We are deep into French crisis territory," Carsten Brzeski of ING told CNBC. He added that there is no imminent liquidity risk for the government. Analysts quoted by CNBC said stronger banks and euro-area safeguards make a repeat of the early-2010s crisis less likely. John Stopford of Ninety One said spreads would probably need to reach "the 200s" before markets broadly treated the situation as a genuine crisis.cnbc.com

Belgian yields also rose sharply this week, while German and Dutch yields fell, the Economic Times noted.economictimes.indiatimes.com

ECB President Christine Lagarde has played down hopes of a rescue. "The primary and first solution lies at home in France. And it has to do with fiscal policies," she said last week, according to Euronews. The ECB's Transmission Protection Instrument has never been used, and to qualify a country must comply with EU fiscal rules. Nomura ↘ 0.66% economist Andrzej Szczepaniak said the bar for intervention is "very high" and that "things would have to worsen a lot from a contagion perspective," Reuters reported.stockwatch.com.cy+1

The ECB is set to meet next Thursday, October 29, and is widely expected to hold rates. Brzeski estimated that the rise in French yields works like a 50-basis-point rate hike, and said "the bond market has taken over the ECB's job."