Bond Market Update: Market Optimism Ahead of French Elections Drives Strong Demand for Long-Term Bonds

Summary:

• Market Complacency: The auction results indicate that market participants are optimistic about the upcoming second round of voting in France, expecting that Marine Le Pen’s National Rally party will not secure an outright majority.
• Investor Confidence in Duration: Despite the considerable duration risk, investors showed strong interest in long-term bonds, reflected in the high bid-to-cover ratios for the 30-year and 40-year OATs, suggesting a willingness to accumulate duration.
• Short-Term Gains from Yield Decline: Investors are strategically positioning themselves to gain from a potential short-term decline in yields, as a 20 basis point decrease in 10-year yields over the course of a month could yield a 2% return, with even higher gains of more than 5% for the 30- and 40-year tenors.

France successfully raised €10.5 billion today by issuing the following long-term bonds:

• 9-Year Bonds (FR001400H7V7): €3.98 billion sold, paying a coupon of 3%, with a cash price of 98.69. The bid-to-cover ratio at the auction was 2.7x.
• 10-Year Bonds (FR0013313582): €3.59 billion sold, paying a coupon of 1.25%, with a cash price of 83.45. The bid-to-cover ratio at the auction was 2.41x.
• 30-Year Bonds (FR0014004J31): €1.72 billion sold, paying a coupon of 0.75%, with a cash price of 49.18. The bid-to-cover ratio at the auction was 2.63x.
• 40-Year Bonds (FR0013154028): €1.16 billion sold, paying a coupon of 1.75%, with a cash price of 62.08. The bid-to-cover ratio at the auction was 2.64x.

The strong bidding metrics for today’s auctions are particularly noteworthy. Investors clearly showed a preference for the 9-year OAT over the 10-year OAT, likely due to its significantly higher coupon, which is more than double that of the 10-year bond. Interestingly, the bid-to-cover ratios for the 30-year and 40-year OATs were also well above that of the 10-year tenor, indicating that investors are attracted to the deep discounts at which these longer-term bonds are traded, despite the considerable duration risk they entail.

The auction results suggest that market participants are optimistic regarding the upcoming second round of voting this weekend, as expectations are that Marine Le Pen’s National Rally party will not secure an outright majority. The OAT-Bund spread has tightened to 67 basis points from its peak of 81 basis points, indicating that further tightening to around 50 basis points is likely if these expectations are met.

Such a move would certainly benefit duration, as yields remain approximately 10 basis points higher across tenors since last week. A 20 basis points decline in 10-year yields would result in a return of 2%. The same decrease in the 30- and 40-year tenors would yield gains of 5% and 5.5%, respectively. However, the downside risk is significant if the National Rally secures an absolute majority, potentially driving yields higher across the yield curve and resulting in losses particularly for holders of long-term bonds.