The European bond markets have seen notable reactions following the recent European election results, with significant movements in spreads, particularly for French and Italian bonds. Here’s an analysis of the key trends and reactions as observed by UBS’s Sales and Trading desk.

Widening Spreads for French and Italian Bonds:

• Sharp Widening on Monday: Following the weekend’s European election results, French and Italian spreads against German Bunds widened sharply on Monday. The initial widening during the morning trading session prompted some buying interest in French 10-year bonds and Italian short-term bonds, indicating a mixed sentiment among investors. By the end of the day, both countries saw their spreads widen by 7 basis points (bp) relative to Bunds.
• Continued Movement on Tuesday: The trend continued into Tuesday, with the Italian spread briefly tightening against Bunds before widening again. By mid-morning, the French spread had widened by an additional 6bp, while the Italian spread was 4bp wider. This persistent widening suggests ongoing concerns among investors about the political and economic outlook in these countries following the election results.

Selling Pressure on French Bonds:

• Heavy Selling of OATs: The UBS desk noted significant selling pressure on French government bonds (OATs) against Bunds on Tuesday, continuing the heavy selling observed on Monday. This selling activity was primarily driven by real-money accounts, indicating a broader move by institutional investors to reduce exposure to French bonds in favor of the perceived safety of German Bunds.

Flattening Interest in Inflation Curves:

• HICP Curve Movement: The Harmonized Index of Consumer Prices (HICP) curve experienced flattening interest, with both the 5s10s and 10s30s segments closing around 1bp flatter. This flattening trend suggests that investors are adjusting their positions in anticipation of changes in inflation dynamics and interest rate expectations.
• French Inflation Curve Reaction: There was also a notable flattening in the French inflation (FRX) curve, with the spread between French and European inflation generally widening. This movement reflects increased concerns about inflationary pressures in France following the election news and the potential impact on future economic policy.

SSA and Covered Bond Movements:

• EU Bond Moves: The SSA/covered bond desk observed that movements in European Union bonds closely followed those in OATs, with EU spreads widening by up to 3.5bp versus swaps at the start of the trading session. This correlation suggests that broader market concerns about European political stability and economic policy are influencing investor sentiment across different types of bonds.
• Real Money Buying: Towards the end of the trading session, there was some buying interest from real-money accounts in long-end French and Belgian SSAs, indicating selective interest in these bonds despite the overall selling pressure.
• French Covered Bonds: French covered bonds widened by 1-2bp, with the yield curves generally steepening. However, the selling pressure was not as pronounced as in other segments, suggesting that while there is caution, some investors still see value in these securities.

Upcoming EU Bond Issuance:

• 15-Year EU Bond: A new 15-year EU bond is scheduled for issuance on Tuesday. UBS expects the bond to be priced with a premium of around 3bp, anticipating good demand. However, given that EU bonds are not significantly cheaper compared to French bonds, there may be challenges in terms of post-issuance performance.

The recent European elections have had a pronounced impact on the bond markets, particularly for French and Italian debt. The widening spreads and the selling pressure on French bonds indicate investor concerns about political stability and economic policy direction. Meanwhile, movements in inflation curves and SSA bonds reflect broader market adjustments in response to these uncertainties.

As the market continues to react to these developments, it will be crucial to monitor upcoming economic data and policy announcements, as well as investor sentiment, to gauge the future direction of European bond markets.