Political risk cools down and resonates with Bank of America crisis, French and British bonds achieve strong weekly gains within the year.

France and UK bonds are making their way towards one of the best single weeks this year. The driving force behind this trend is the flight to safety triggered by market concerns about the health of US regional banks on Friday. This week, driven by domestic factors, bonds in both countries were already on the rise. After two regional banks in the US disclosed their exposure to problem real estate fund loans, the market fell into panic, further boosting the rise in bond prices. The yield on French 10-year government bonds has dropped by 16 basis points to 3.32%, reaching its lowest level since August last year. The reason behind this is the postponement of President Macron's proposed pension reform plan, which temporarily averted the immediate risk of the government collapsing. This change has also caused the spread between French and German borrowing costs - a closely watched risk indicator - to decrease by 5 basis points to 78 basis points, marking the biggest narrowing since June. At the same time, the yield on UK 10-year government bonds has fallen even further, dropping by 18 basis points in a single week to below 4.50%, the lowest level in three months. As UK unemployment rate climbs, Bank of England Governor Bailey made comments about the job market, further strengthening market expectations that the Bank of England will maintain loose monetary policy. Evelyne Gomez-Liechti, strategist at Mizuho International, said: "It can be said that both countries' bonds have to some extent benefited from the 'diminishing political risk premium', but for the UK, it is more based on 'expectation', while for France, it is more based on 'actual situation'." French Prime Minister Jean Castex suspended the pension bill that would raise the retirement age, avoiding the risk of an early election, and French bonds rose as a result. This move was crucial in helping him gain support from Socialist Party parliamentarians in a vote of no confidence - without this support, he could have easily lost in the vote on Thursday. However, the risks are far from over. French lawmakers with severe divisions have yet to reach a consensus on the budget, and credit rating agency assessments are imminent. But for a political crisis that almost sparked early elections this week, the current situation is a respite. Next month, the UK will also face a test with the budget. Chancellor of the Exchequer Rishi Sunak must achieve fiscal balance within limited policy space, and she has informed Cabinet colleagues of her intent to control spending. Michiel Tukker, senior European interest rate strategist at ING, pointed out in a report to clients that investors need certainty on the UK budget, but the rise in UK government bond prices this week is "a reasonable trend" and there is still room for further yield decline. Since President Macron announced early parliamentary elections last year, leading to a suspended parliament, France's borrowing costs have consistently been higher than those of other similar countries. This political deadlock has pushed French government bond yields to the highest in the Eurozone, even surpassing countries like Greece and Portugal that were once shunned by the markets. Credit concerns As France's fifth prime minister in two years, Castex made concessions on the pension bill when his position was in jeopardy. Last week, he resigned due to internal cabinet disputes, and then on Friday accepted Macron's new appointment - with Macron's own position significantly weakened. Although this concession boosted the market this week, it has made the path towards fiscal consolidation in France more complicated - fiscal consolidation being the core issue of concern for credit rating agencies. Moody's will release an assessment report next Friday, which will be another obstacle for France in the near future. The agency had warned last year that a regression in pension reform could have a negative impact on France's credit rating. If Moody's or S&P Global downgrade France's rating, breaking a key threshold, it would force investors subject to rating restrictions to sell French government bonds. France currently has an average credit rating of AA, meeting the requirements for such investors. However, given Fitch's downgrade to A+ in September last year, if further downgraded, these investors will be forced to sell their holdings of French government bonds. Macro strategist Ven Ram said: "After Prime Minister Castex won the vote of no confidence this week, France seems to have found some political stability, but from a credit rating perspective, pausing pension reform is not good news - this is why credit rating assessments next week are crucial for investors." Currently, the market is gaining confidence from signs that French policymakers can garner enough support to pass the budget and prevent the government from falling apart. Jane Foley, head of forex strategy at Rabobank, said: "With the French budget now likely to pass, overall, this is better than being unable to pass the budget."