French borrowing costs rise above Spain's for first time since 2008

France's borrowing costs briefly rose above Spain's for the first time since 2008 on Tuesday, according to LSEG data, in a sign of investor concerns about the new French government's ability to tackle the high budget deficit.

Longer-dated euro zone bond yields ticked up slightly earlier in the session before sliding into negative territory, while more interest rate-sensitive shorter-dated yields fell further after US consumer confidence data unexpectedly fell in September.

They had slipped earlier in the day as investors nudged up their bets on another European Central Bank rate cut in October, after weak economic data on Monday.

Spanish bonds have traded with higher yields than French bonds since the financial crisis as the country is traditionally seen as a riskier investment.

But the so-called spread between French and Spanish 10-year bonds briefly fell into negative territory in morning trading in Europe, with both trading around 2.98%, before rising again to stand at around 1.8 basis points.

"The market is obviously reacting to developments in France," said Emmanouil Karimalis, macro rates strategist at UBS.

"Still there is no clarity in terms of fiscal (policy), and we also had very negative PMIs yesterday," he said, referring to survey data that on Monday showed France's business activity unexpectedly contracted in September.

Investors have sharply increased the premium they demand to hold French debt compared with the country's euro zone peers since President Emmanuel Macron called a surprise election in June. The poll resulted in a hung parliament, with the leftist bloc unexpectedly becoming the biggest grouping.

France's newly appointed finance minister Antoine Armand on Tuesday acknowledged concerns over his young age and lack of experience and said the country faced "one of the worst deficits in our history". The deficit could reach 6% this year, well above the European Union's limit of 3%.

The German 10-year bond yield, the benchmark for the euro zone bloc, was last slightly lower at 2.148% after falling 5 bps on Monday. Yields move inversely to prices.

Germany's two-year bond yield, which is more sensitive to European Central Bank rate expectations, was down 6 bps at 2.104%, around its lowest since March 2023.

Traders on Tuesday saw an over 50% chance of an ECB rate cut in October, up from around a 15% chance at the start of the week, according to money market pricing.

Monday's survey data showed euro zone business activity as a whole contracted sharply and unexpectedly this month as the dominant services industry flatlined.

"The decline in the euro area PMIs to levels below all estimates is reviving speculation about the next ECB rate cut already in October," said Christoph Rieger, head of rates and credit research at Commerzbank.

China's unveiling of the largest stimulus package since the pandemic, aimed at boosting an economy weighed down by a property crisis, did little to move euro zone bonds.

Italy's 10-year yield was down 3 bp at 3.495%.