The Oat Spread As A Credibility Score
France's 10-year OAT spread to German Bunds is not simply a measure of relative credit risk. It is a composite score that prices political fragmentation, deficit delivery uncertainty and the ECB's tolerance for peripheral-style widening in a core issuer simultaneously. Understanding which component is driving the spread at any given moment is essential for taking a view on its direction.
In the period from January to June 2024, the spread widened from 50bp to 80bp. The driver was political risk: the surprise dissolution of the National Assembly in June 2024 and the subsequent hung parliament outcome removed the fiscal majority that the Macron government needed to implement its structural adjustment plan. The market was pricing legislative gridlock, not French credit fundamentals.
By early 2026, the spread had compressed to 62 to 65bp under a new government with a slightly more workable majority, demonstrating that the political risk premium is mobile. The question for the 2026 investment thesis is whether further compression is achievable, or whether the structural level of the spread has reset higher permanently.
The Deficit Arithmetic
France's 2025 deficit outcome of approximately 5.2 percent of GDP must be evaluated in context. In 2020, France ran a deficit of 9.1 percent of GDP and the OAT spread barely moved because the ECB's pandemic emergency purchase programme (PEPP) provided an implicit backstop for all European sovereign bonds. The post-PEPP world is different: the ECB's residual flexibility under the Transmission Protection Instrument (TPI) is conditioned on compliance with EU fiscal frameworks, which France is now violating under the Excessive Deficit Procedure.
The EU's EDP requires France to reduce its structural deficit by approximately 0.5 percentage points of GDP per year. The current government has committed to this path in its Stability Programme submitted to Brussels. The credibility of that commitment is the central investment question. On current trajectory, France reaches the 3.0 percent deficit target in 2028 to 2029, assuming: nominal GDP growth of 1.6 percent annually; structural spending restraint of EUR 15 to 20 billion per year; and no new spending commitments from political shocks.
Each of those assumptions is fragile independently. Together they require a sustained political discipline that France has not demonstrated consistently. Track the autumn budget presentation, typically September to October, as the most important annual signal.
Ecb Optionality
The Transmission Protection Instrument, introduced by the ECB in July 2022, created a conditional backstop for sovereign spreads of member states in compliance with EU fiscal frameworks. The key word is conditional: TPI is explicitly unavailable to sovereigns that are not adhering to their EDP adjustment paths.
This conditionality creates a non-linear dynamic for OAT spreads. As long as France is making credible progress on EDP compliance, TPI is theoretically available in a stress scenario and provides a ceiling on spread widening. The moment the market perceives that TPI is unavailable (because France is in material non-compliance), the spread can gap significantly wider without a natural backstop.
The desk estimates that TPI availability is currently priced as roughly 70 percent probable in the OAT spread. Remove that optionality and the theoretical floor for TPI-less OAT spreads in a political crisis is in the 120 to 150bp range, consistent with the 2011 to 2012 episode when OATs briefly traded at 180bp over Bunds.
The 2027 Election Risk
The 2027 French presidential election is 12 months away and is already visible in the OAT spread. The current government's polling suggests a first-round outcome that could produce a run-off between a centrist candidate (most likely from the current government's coalition or its successor) and either Marine Le Pen's Rassemblement National or Jean-Luc Melenchon's left coalition.
The spread is currently pricing approximately 15 to 20bp of election risk premium on top of the fundamental fiscal spread. That premium will expand as the election approaches and opinion polls sharpen. The desk estimates an additional 10 to 15bp of widening in the 6-month window before the April 2027 first round, irrespective of the fundamental fiscal trajectory.
A Le Pen or Melenchon victory would immediately test TPI conditionality: both have proposed fiscal programmes inconsistent with EDP compliance. The spread implications of a RN or left-populist government in France are severe, in the 100 to 140bp range, and would represent a structural break from the current trading range.
Positioning
The desk maintains a tactical short OAT against long Bunds at current spread levels around 63bp. The carry cost of this position is low and the convexity is asymmetric: the upside in a French political shock is 50 to 90bp of additional widening; the downside in a fiscal surprise to the upside is 15 to 20bp of compression.
For real money accounts with mandate constraints: OAT underweight relative to the euro government bond index is the appropriate expression. The absolute level of French yields does not justify outright short positions for most mandates, but relative underweight captures the political risk asymmetry.