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French bonds rallied on Monday on expectations that Emmanuel Macron a fervent EU supporter will beat Marine Le Pen in the second round run-off for the French election.

But folks at Capital Economics note that the rally is unlikely to last even if Mr Macron were to win.

French government bonds were rattled in recent months on rising fears that an anti-EU candidate like Ms Le Pen or Jean-Luc Mélenchon could win the election. But Mr Macron’s win in the first round on Sunday helped cheer markets.

Indeed, the 10-year French OAT yield, which moves inversely to price, fell 9.9 basis points (0.09 percentage points) to 0.826 per cent on Monday, while that on the 2-year declined 13.9 bps to 0.467 per cent.

Despite investors’ upbeat view on French bonds on Monday, Daniel Christen at Capital Economics says that the rally is unlikely to keep going as perceptions of France’s creditworthiness have changed and as the European Central Bank begins to unwind its bond-buying programme.

First, he notes “a key reason for the rally in French OATs has been the diminishing chance of one of his two radical rivals gaining power” and Sunday’s vote eliminated the threat of second round run-off between Ms Le Pen and Mr Mélenchon.

While polls now indicate that Mr Macron, the independent centrist who won the largest share of the vote, could go on to succeed outgoing president Francois Hollande, the “French state is no longer perceived to be as creditworthy as it once was, reflecting France’s high and rising public debt, and stubbornly high structural deficit,” Mr Christen argues.

French GDP growth has often been below the eurozone average and is expected to rise just 1.7 per cent this year, according to the IMF’s World Economic Outlook. The country’s general government gross debt is estimated to have stood at 96.6 per cent of GDP last year, according to the IMF, which also forecasts that the nation’s government deficit will breach 3 per cent — the limit set by the EU’s growth and stability pact — this year.

Moreover, the yield on France’s government debt has typically been close to German Bunds, signalling that it is one of safest sovereign debt to own. That relationship began to break down in late 2016 but the spread of the 10-year OATs over German Bunds has fallen back since the results.

Mr Christen notes, however, that the phasing out of the ECB’s quantitative easing programme is also likely to “prevent a major narrowing of the spread”.

QE had brought down the 10-year Bund yield and OAT spread amid a “hunt-for-yield” and as the central bank begins to unwind QE this development could begin to unwind as well.

“With these two factors weighing against the improved political outlook, we think that the OAT spread is likely to end this year and next around its current level and could rise again if Macron fails to keep the budget in check or implement his reforms,” Mr Christen, said.

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