AFS Markets Blog: Midday 28/09/2026

• Meanwhile in markets, the path of the least resistance is for the OAT-Bund spread to widen even further. The level I have in mind is 146bps, which is the 2012 Eurozone peak – months before then ECB President Draghi ad-libbed his famous “whatever it takes” line that quelled the Eurozone crisis;

• At pixel time, the 10y OAT-Bund spread had risen to 111bps, the highest level since the Eurozone crisis. OATs are hit by a triple of whammy of domestic political risk, hawkish ECB repricing, and the global bond sell-off that has hit fiscal sinners like France proportionally harder;

• Starting with the key driver of Bund spread widening, domestic political risks, I think the odds of the government passing an austerity budget for 2027 without substantially more market pressure (read: much wider spreads) are low. President Macron’s hapless government (for the record: Macron is on his fifth Prime Minister in his second term) lacks a majority in the National Assembly, where no party or bloc commands a majority anyway. The government of Prime Minister Lecornu targets a deficit this year of slightly below five percent of GDP. Because of disappointing growth, the actual deficit will likely remain stuck at around five and a half percent of GDP.  Lecornu wants to give deficit busting another try with next year's budget. But with Presidential elections in April, I see no reason why the opposition would help Lecornu unless France’s bond market access is truly at stake;

• Probably a bigger risk for OATs are next year’s Presidential elections. This morning we had another poll showing that the run-off vote in early May will likely be between the far right Marine Le Pen and the far left Jean-Luc Mélenchon. Obviously, Le Pen is the market’s preferred candidate for the simple reason that Mélenchon has repeatedly called for a partial sovereign default while Le Pen hasn’t. Still, while Le Pen’s fiscal campaign promises look good on paper with a promise to cut spending by 125 billion euros over five years, the numbers do not add up. Quelle surprise. More importantly, nobody knows if she will get the majority in the National Assembly that is required to commit to such an ambitious austerity program;

• When elected President, Le Pen will likely trigger Article 12 and dissolve parliament. New elections for the National Assembly will then be held within two months. But if the pollsters are any guide, the odds of Le Pen’s RN party securing a majority are barely a coin toss. So, to use market parlance, the visibility on France getting its fiscal house in order are pretty dismal. And, by the way, was the last time the French got their house in order with a sound budget? I am an old-timer and I simply can’t remember.

• I think for the OAT-Bund spread to stabilize we must see one of several things. Parliament passing an austerity-lite budget for 2027; polls consistently showing Mélenchon not making it to the second round; or polls consistently showing high odds of Le Pen’s RN party securing a majority in the National Assembly;

• Finally, don’t count on the ECB fire brigade to quell spreads. Yes, the ECB has a bond buying program named TPI that the central bank can use on its own discretion. But even France must accept some conditionality in exchange for ECB support in the bond market;

• Turning to some market commentary, around noon Bund yields are up 2-5bps across a bear-flattening curve. For the 10y and 30y I clock twenty and fifteen year highs, respectively. Keep an eye on the BTP-Bund spread, which is collateral damage of the French turmoil. At 94bps, we’re only slightly below the magic number that is 100bps;

• Higher energy prices are predictably weighing on bonds this morning. Brent crude is up three percent at $107.54 a barrel while Natgas is up three percent to 74.15 euros per MWh. Energy futures prices are higher after President Trump dismissed Iran’s overture for a deal that would reopen the Strait of Hormuz within a week. However, the President didn’t close the door on a deal entirely, telling the US news outlet Axios that he expects more talks with Iran this week. Furthermore, Qatar, a major LNG exporter, extended force majeure through the end of the year;

• ECB and Fed pricing remains hawkish, with forwards pointing to a terminal rate of 3.5% in the case of the former and 5.0% in the case of the latter. Be aware that hawkish central bank pricing reflects inflation (fears) as much as buoyant AI-driven economic growth. Regarding the latter, a case in point is this morning’s outlook upgrade by freight company Kuehne+Nagel. The Swiss company said that it expects three years of double digit growth in transport related to the AI boom;

• Looking ahead, today’s calendar is empty except for ECB President Lagarde’s testimony before EU Parliament. Which will likely be more about her expected early exit than anything else. The calendar for the rest of the week is packed with major central bank speakers every day. Also keep an eye on the revision of US PCE inflation data on Wednesday, which will likely end up lowering inflation somewhat. The main event is Friday’s US labor market report for September, where consensus expects a solid 100k or so increase in headline payrolls. That will help seal the deal on another Fed hike next month.

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