OAT: OAT/Bund Spread Consolidates Around 86bps; Analysts Flag '25 Election Risk
- After widening to a knee-jerk high of 89bps following PM Lecornu’s resignation, the 10-year OAT/Bund spread has consolidated around 86bps. While the timing of Lecornu’s resignation came as a surprise, intraday widening has been limited by the fact Lecornu’s prospects of passing a 2026 budget were appearing bleak from the onset. Lecornu’s resignation today may have just delayed the inevitable.
- Today’s moves in spreads can be classed as orderly and reflective of fundamentals (i.e. political/fiscal risk premium). That should dispel any fresh speculation around the use of the ECB’s TPI – something almost all Governing Council members have strongly pushed back on in recent months.
- In an interview with the MNI Policy Team, a Greek treasury source noted that “investors don't doubt that the ECB or the EU would step in the case of an unwarranted dysfunction in European sovereign debt markets.”. While not an immediate concern right now, this implicit backstop may also contain blowout episodes in spreads without requiring a formal triggering of the TPI.
- Sellside views following Lecornu’s resignation highlight the challenges facing France. Some note that fresh legislative elections may come as soon as this year:
- Barclays: Macron has two main options: "appointing a new Prime Minister or dissolving the National Assembly. Even if President Macron chooses the former, we now think that early legislative elections are the baseline before year-end."
- Commerzbank: “After two centrist politicians have failed in quick succession, the choice is likely to fall on a moderate right-wing politician or a left-wing politician. The latter is the more likely scenario”…“a prime minister from the left-wing camp is likely to focus on higher taxes in the budget dispute and intensify conflicts with Macron's camp”…“ there are no signs of a resolution to the political deadlock, and a consensus on ambitious reforms of public finances remains a long way off.”
- Berenberg: “This further increases the risk that France's fiscal troubles will remain unresolved and that economic policies will become less growth-friendly. It adds to the risk that France may be heading for new parliamentary elections in late 2025 or early 2026.”
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LOOK AHEAD: US Macro: PPI (Wed) and CPI (Thu) Inflation
US PPI inflation is released on Wednesday before CPI inflation on Thursday, an unusual ordering that should see core PCE implications dialled in after the CPI release rather than the usual wide range waiting for specific PPI details. PPI will be watched more closely than usual this month after a far stronger than expected jump in last month’s July report fired a warning short over tariff-based cost pressures starting to feed through. That included a 0.6% M/M increase in our preferred core series of PPI ex food, energy & trade services, which strips out items such as the then booming portfolio management & investment advice category following the strength in equity markets. It's too early to gauge an accurate sense of analyst expectations for August.
CPI inflation on Thursday will then be the last major release ahead of the Sep 17 FOMC decision. Consensus looks for core CPI at 0.3% M/M after the 0.32% M/M in July, another monthly increase comfortably above a pace consistent with 2% inflation. August should in theory start to see the largest tariff impacts along with September and possibly October. Returning to July’s report, core goods inflation was softer than expected, at a still solid (by core goods standards) 0.2% M/M for a second month running but about half that of 0.4% expected by analysts. Instead, non-housing core services surprised higher. The latter was a “dangerous” development in the words of a usually dovish Chicago Fed’s Goolsbee (’25 voter), who speaking after Friday’s payrolls report is still undecided on a September cut whilst looking for August inflation data “to get more information”.
LOOK AHEAD: US Macro: Payrolls Preliminary Benchmark Revisions (Tue)
- The BLS on Tuesday will publish preliminary estimates of benchmark revisions, based off QCEW data for Q1.
- These will give an indication of the actual benchmark revisions on the Mar 2025 level of payrolls due with the Jan 2026 payrolls report released in early February.
- Bear in mind that the final benchmark estimate tends to nearly always be more negative than the preliminary figure – see historical values to the right.
- That doesn’t mean they can’t be large again after last year’s historically negative revision that lowered the level of payrolls by ~600k. Initial estimates we’ve seen look for another large downward revision, with the smallest being worth -550k but with wide ranges higher.
FED: Barclays Adds A Cut To 2025 Fed View
Barclays analysts now expect three Fed cuts in the remainder of the year, adding October to their pre-existing call for 25bp reductions in September and December. "Given the disappointing August employment report, we expect the FOMC to see more elevated downside risks to the employment side of the mandate."
- As for a 50bp September cut, "we think that the FOMC will view [that] as sending too strong a signal that labor market conditions are deteriorating. Indeed, we think that participants such as Powell understand that the slower pace of payroll employment reflects at least, in part, slower labor supply, which does not translate into increased labor market slack."
- For 2026 they continue to expect 25bp cuts in March and June to 3.00-3.25%, but "we do not think the FOMC will be able to cut rates more than twice next year, as we think that activity will show some slight acceleration, with the economy adapting to the new tariff environment and fiscal policy providing some support, and the unemployment rate will revert down amid limited increase in labor supply."
