Rising French government bond spreads are sparking concerns about the stability of European equities, as political uncertainty and higher global borrowing costs strain France's public finances. Bank of America (BofA) notes that while further increases in yields pose risks, the spread between French and German bonds, known as the OAT-Bund spread, is expected to remain within a range of 100 to 150 basis points. The current spread has reached 140 basis points, the highest level since the euro zone debt crisis of 2011-12, reflecting both rising global bond yields and political uncertainty in France.
Despite these challenges, BofA upgraded French equities from marketweight to overweight, citing their sharp underperformance and the belief that much of the fiscal risk has already been priced in. The bank's rates strategists expect limited additional widening in the OAT-Bund spread, which could activate policy backstops, including potential European Central Bank intervention. However, BofA maintains a bearish outlook on the broader European market, forecasting a 7% decline in the STOXX 600 to 580 by the second quarter of 2027.
The bank attributes the recent 5% decline in European equities from their August record high to a 50-basis-point rise in yields rather than French fiscal risks. BofA remains negative on European equities outright but has turned less negative on European equities relative to global stocks, raising its stance from underweight to neutral. This shift reflects concerns about the sustainability of the artificial intelligence capital expenditure boom and the risk of elevated valuations leaving equities vulnerable to higher real yields.
BofA also downgraded software stocks to marketweight from overweight after the sector outperformed by 30% since the summer. The bank's more constructive stance on France is based on the view that the OAT-Bund spread has limited room to widen further, potentially limiting additional pressure on sovereign debt. However, this does not signal a broader bullish turn on European stocks, as BofA continues to see downside for the regional benchmark.