Good morning. Everything is terrible and stocks are at record highs. OK, “terrible” might be an exaggeration, but corporate America is starting to suffer from the rise in borrowing costs, and for good measure, here’s the CEO of the world’s largest independent oil trader warning of $200-a-barrel oil. And yet the S&P 500 has never had it so good·. As we’ve discussed already this week, in this newsletter and in its sister podcast, the answer to this apparent madness of course lies in AI. Tell us why this is fine, actually: [email protected].
Uh OAT
French government borrowing costs have shot up more than 1.5 percentage points since the start of the Iran war and more than 0.5 percentage points in just the past month. We’re not quite in debt crisis territory, but we’re not far off: the all-important OAT-Bund spread — the difference between French and German 10-year borrowing costs — peaked at 1.6 percentage points last week before falling back to just shy of 1.3 percentage points yesterday.
The start of the budget process last week may have halted the sell-off but it hasn’t done much to dispel the sense of dread that’s threatening to hang over the French economy from now until the presidential elections next spring. For yesterday’s Big Read, a team of our intrepid news colleagues summed up what’s at stake:
Tensions are rising as the confrontation over the budget deepens and the country prepares for an April presidential election that could end in a face-off between the far right and hard left.
The fear among investors is that the country could be tipped into a full-blown debt crisis that could not only rock France’s economy but also shake the Eurozone.
On Monday, the euro fell to a 17-month low against the dollar as worries intensified about the impact of the French debt sell-off on the single-currency area.
Obviously, the best possible outcome would be for France to pass the budget and get serious about fiscal consolidation, but we’re not counting on it; the country hasn’t run a balanced budget since 1974. Unhedged would never wish for a full-blown debt crisis, but absent a structural fix to the toxic mix of low growth and high debt, we can almost understand the arguments of those that do. Until then, we’re stuck in something of a stalemate.
But if there’s one thing a looming crisis is good for, it’s the increasingly outlandish ideas about how to fix the mess at little or no cost (aka “one neat trick to rid you of this troublesome bond market”). Here, in no particular order, are a few of the proposals in the air.
The European Central Bank should intervene in the French bond market. This is the idea that the central bank should use its balance sheet to mop up OATs, bring down yields and restore calm. Market discussion has focused on the transmission protection instrument, an as-yet untested tool introduced in 2022 to “counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area”. Never rule out some kind of fudge to justify wheeling the TPI out, but right now the ECB has little mandate to use it. OATs are being repriced but the market is functioning fine. It would work, but it’s probably not going to happen, at least not without a big outbreak of infectious market instability. Activating the TPI for what is largely a political jam of France’s own making would be extremely controversial and almost certainly trigger political and legal backlash across the wider Eurozone.
The ECB should stop shrinking its balance sheet. Since 2023, the ECB has been letting the bonds it purchased under quantitative easing to roll off at maturity rather than reinvesting the proceeds in new bonds. Its balance sheet reduction programme has been among the slowest of the lot, but there’s no question that the retreat of central banks from government bond markets has put upward pressure on rates. Continuing to reduce the balance sheet during a global sell-off is unhelpful. It should probably stop. Here’s former ECB policymaker Lorenzo Bini Smaghi making the case:
[R]eturning to normal has been presented by the central bank as an “obligation”, motivated apparently more by nostalgia for the world that existed before the financial crisis than by rigorous analysis. In fact, there is nothing inherently “normal” about the size of a central bank’s balance sheet, especially when underlying economic and market conditions change in fundamental ways over time.
This may be the least contentious proposal. But it’s not without its issues. What it would mean in practice is that the ECB would restart bond purchases, replacing maturing bonds with new ones, to keep the balance sheet at its current level. Some will call this QE in all but name. Let them. There’s a difference between expanding the balance sheet to stimulate the economy and choosing not to shrink it during market volatility.
France should cancel the debt it owes to itself. OK, we feel like we might lose brain cells even trying to explain this one. But this is the idea from the far-left party La France Insoumise to convert €488bn of the OATs that the Eurosystem bought during QE into perpetual, zero-coupon debt. In other words, the bonds would stay on the central bank’s balance sheet, but France would never pay interest on them and never have to repay the principal. The problem is the central bank would still need to pay out interest on the reserves it created to purchase the debt and the bond market might take fright at a government so willing to meddle with its debt obligations.
Of the three, only the QT pause has any chance of happening, and it would barely move the needle.
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