OATs reel from blows but no quick fix in sight

How can we expect news on French finances to develop? And what do ECB policy and US mid-terms have in store for the market? Crédit Agricole CIB’s Louis Harreau, head of developed markets macro and strategy, and Valentin Giust, global macro strategist, share their views.

Neil Day, Bank+Insurance Hybrid Capital: How do you explain the situation in OATs?

Louis Harreau, Crédit Agricole CIB: Let’s start with what happened over the past four weeks. In our view, sentiment around France has been hit by three blows.

The first is clearly the increase in political uncertainty. If you look at the polls, they are increasingly showing a second round run-off between Jean-Luc Mélenchon and Marine Le Pen, and evidently that is not something that is especially market-supportive. The relatively high level of support enjoyed by Mélenchon in recent weeks suggests he is running a very efficient campaign. Meanwhile, the campaigns of mainstream candidates — Édouard Philippe, Gabriel Attal, and even Bruno Retailleau — do not seem to be going particularly well. This evolution in polls, with the far right and extreme left performing so strongly, was a wake-up call for markets.

The second element that could have increased worries in the market is the fact that France’s economic outlook is deteriorating. Firstly, the Q2 GDP number was relatively bad. And secondly, the 2026 deficit will be worse than expected: compared to a deficit of 5% that had been expected by the government, Sebastién Lecornu announced that is will be 5.4%. So you have deteriorating growth, and on top of that a larger than expected deficit. This is something that began worrying the market during the summer.

And the third blow is the fact that France — like every country in the developed world — is currently facing higher rates. For France, with relatively high public debt, this higher rate will imply a higher cost of debt, and consequently, a higher risk of refinancing in the market for the future, and furthermore, this higher cost of debt could naturally increase the public deficit and consequently public debt.

The combination of those three elements has triggered the recent worries on the French market.

Day, BIHC: How might the situation worsen or stabilise in the coming months?

Valentin Giust, Crédit Agricole CIB: We have been worried about the public finances, and we remain worried. What is worrisome is that we currently do not see a clear way out. If you look at the public finances, two years ago, it was a far from perfect situation: successive governments tried to implement measures, but these were almost always rejected by the National Assembly. Now this problem is compounding, and that’s why if you look at the fiscal outlook, you have a deficit currently which is between 5% and 5.5%. If fiscal policy is not adjusted, it will be higher and higher, which implies an upward trajectory for your debt-to-GDP ratio. Moreover, this upward trajectory is likely to accelerate. That’s why it’s so worrying. We lost around two years, since 2024, and now the market environment is more adverse, there is a compounding effect with spreads, and at the same time, this refinancing issue and this deficit issue is far from being tackled. The government is willing to address it, but it has absolutely no political leeway to change course. So that is the negative inertia that we expect, which is why we are not positive over the medium term.

Day, BIHC: Going back to Le Pen, she announced RN plans aimed at addressing this on Tuesday. Are they helpful?

Giust, Crédit Agricole CIB (pictured): The good thing is that they have now acknowledged the current market situation. They clearly believe that it needs to be resolved and are addressing it — that is welcome. And the numbers they are targeting regarding deficit reduction are appropriate: a reduction of something like €140bn per year, which is more or less in line with our figures — this was €120bn before the sell-off, but currently more like €150bn.

However, if you look at the measures they are proposing, these are far from a package that could achieve that. With those measures, it’s very difficult to foresee an adjustment of even a third of what is necessary. So basically, they are aware of the destination that needs to be reached, but the path to get there remains quite uncertain — although it’s worth noting that none of the other parties have outlined plans that clearly address the current French weakness, either.

Day, BIHC: How do you expect the ECB to react to current economic developments and the French situation?

Harreau, Crédit Agricole CIB: In terms of monetary policy, we expect the ECB to remain on the hawkish side. Granted, there is this particular French aspect, but at the same time, you still have core inflation that is increasing, and consequently, it is still necessary for the ECB to hike its rate. That’s why, whatever happens in France, good or bad, we still expect the ECB to hike again, at least once in December, and possibly another time later on. The ECB should continue its monetary tightening; it should not look only at France when implementing monetary policy. On this front, we would not anticipate any dramatic change in our view.

We can agree that in a scenario where France triggers a kind of financial crisis, the ECB would have to be more accommodative. But that’s not at all the scenario currently. We are not talking about a full-blown crisis for France. So that’s on the on the monetary stance.

Now, if I look at the other aspect that is heavily discussed in the market, whether the ECB would have to intervene on the market to protect French OATs: first of all — and this is very important — we are not there yet at all, because the French spread is currently not that large. Markets are still relatively confident in France’s credibility. But in an adverse scenario, the ECB could intervene in the market, like it did in the past for Greece, for example, or to a lesser extent for Italy and Spain. The ECB could intervene, but only under two conditions, in our view. The first is that tensions are sufficiently large to threaten the implementation of monetary policy. That would be reflected in a significantly larger spread of OATs over private assets, corporate bonds, covered bonds, etc. You would need a larger spread to trigger such an intervention. The second point is that the ECB would only intervene if it is in front of a government that is ready to implement adequate policies. There is no universe in which the ECB just unilaterally saves a government that does not have sound public finances. So the conditions for the ECB to intervene are by no means met here: financial tensions are relatively limited for now, and we are not in a situation where the French government has shown that it is ready improve public finances sufficiently.

Day, BIHC: Putting France aside, how might the ECB be reacting to wider geopolitical and macro developments?

Harreau, Crédit Agricole CIB (pictured): The ECB has to take into account the volatility in energy commodity prices in its inflation forecast, and what we have seen is that prices, especially of gas, have dramatically increased since the beginning of August, the beginning of July, even, and this has an impact on its core inflation outlook. The ECB revised upward its inflation outlook in September, and it will probably revise it marginally upward again in December. As a consequence, the ECB has to remain on the hawkish side, because core inflation will remain relatively high in the year ahead.

Unfortunately for the ECB, it is still super-dependent on the evolution of energy commodity prices, so it’s very hard for it to have a clear view on the outlook for its monetary policy. That also explains the volatility in the rates market: as the ECB faces a lot of uncertainty, it cannot provide clear communication, and without clear communication from the central bank, it’s very hard for markets to adequately price monetary policy steps.

Day, BIHC: Inflation is apparently high on the agenda of American voters, too. Do you expect the mid-terms in the US to have an impact on economic and financial developments?

Giust, Crédit Agricole CIB: We don’t expect a major impact, for two reasons. First, the backdrop is very uncertain, so it’s really difficult to see a resolution to that, and the mid-terms are a relatively minor event amid all that uncertainty. And second, we do not see how practically a significant change in the House and the Senate in the US can reverberate toward something really changing in the variable that really counts: if you look at US inflation, there is very little probability of seeing something significant unfold. OK, Trump is willing to send cheques to the American people if he gets a full majority in both chambers, and yes, that would probably be inflationary and change the outlook. But this is far from the central scenario. The opposite outcome — which is probably the most likely scenario — of the Democrats gaining the Senate and the House, we do not believe that will change the situation in the Middle East. If you look at the Strait of Hormuz, for instance, yes, there is no outright conflict — more of a proxy war — but the Strait is completely blocked and we do not see how the Democrats can unblock it. There may be some kind of negotiation, but it would take months, while Trump remains at the helm. So we do not expect a major impact from the mid-terms in most central scenarios.

Day, BIHC: Overall, it doesn’t sound like a pretty picture. Are there any glimmers of hope on the horizon?

Giust, Crédit Agricole CIB: The good thing — although not necessarily good for the rates environment — is that if you look at growth, it has been outstandingly robust since the start of the year. This is not the case in France, but if you look at growth more generally, in the US, there’s a slight deceleration but it remains super-constructive, and you have very positive surprises in other countries, like in Germany, like in the UK recently. That’s probably paving the way for more restrictive monetary policy, on the one hand, but clearly, at the same time, it means that the economy is not currently underwater, and this is more like an upside of the cycle, which is good news.