Euro zone bond markets set sights on French presidential election

LONDON: The premium investors demand for holding French government bonds over German peers tightened to a one-week low on Tuesday after a poll showed centrist independent Emmanuel Macron leading in the first round of France's presidential election this Sunday.

In a surprise highlighting election risks in Europe, Britain's Prime Minister Theresa May on Tuesday called for an early election in June -- pushing British gilt yields lower and adding to downward pressure on safe-haven German Bund yields.

But for euro zone bond markets, the main focus remained this Sunday's French presidential election.

An Ifop-Fiducial poll on Tuesday showed Macron taking 23 percent of the vote in the first round of voting, with far-right anti-euro candidate Marine Le Pen on 22.5 percent. Conservative Francois Fillon and far-left candidate Jean-Luc Melenchon were both on 19.5 percent.

A surge in support for Melenchon in recent weeks has unnerved markets and analysts said while the latest poll had bought some relief, markets were likely to remain on edge before Sunday's vote.

"Every poll that is coming out now is being scrutinised closely," said DZ Bank strategist Christian Lenk. "Nevertheless, markets remain very nervous ahead of Sunday."

France's 10-year government bond yield reversed early rises to trade slightly lower on the day at 0.89 percent .

That briefly tightened the gap over German peers to around 70 basis points, its lowest level in about a week and down from six-week highs hit last week around 78 bps.

Germany's benchmark 10-year Bund yield also was marginally lower at 0.18 percent, trading in line with most other higher-rated euro zone government bonds.

COUNT DOWN

Opinion polls suggest the election in the euro zone's second biggest economy will come down to a final battle between independent centrist Emmanuel Macron and Marine Le Pen, head of the anti-European Union and anti-immigrant National Front.

But the race has tightened and while no polls have show Le Pen missing out on the run-off, to take place on May 7, they are now within the margin of error and any two of the four top candidates have a shot at qualifying.

That uncertainty means any recovery in French bonds could be short-lived.

"Investors are going to be very careful this week and clearly the only thing that's going to be on their minds is what happens in France," said Chris Scicluna, head of economic research at Daiwa Capital Markets.

"Macron will win if he can get through to the second round but the question is whether he will actually get there."

France's presidential race, one of the most unpredictable in decades, is viewed as a key risk event for markets with investors cautious after last year's shock Brexit vote and the unexpected election of US President Donald Trump.

International Monetary Fund Managing Director Christine Lagarde told German newspaper Die Welt in an interview published on Tuesday that there is clearly rising concern about the French election outcome.

The jitters are also reflected in currency markets, where the cost of hedging against volatility in the euro over the next month against both the dollar and yen on Monday jumped to the highest levels since the results of Britain's vote to leave the EU last June .

Liquidity in general across euro zone bond markets was thin as traders returned from the Easter break and reacted to recent French poll results.