AUGUST 14, 2026, EUREX:FOAT / EUREX:FGBL

(No) Country for Old Men

#sovereign #rates #france #politics #spreadtrade

Executive Summary

The title is misleading for some and paradoxical for others. Our beloved country is effectivement the country for old men, and will be, until it won't. For those who wonder, the title comes from one of Cormac McCarthy's most famous novels.

We have lost faith in France's political process and are désormais short the French OAT/Bund 10-year spread. We believe the risk premium for holding French long-term bonds will rise, at least until the presidentials, where the polls are compassing France towards an MLP presidency. But is that the case ? Are other candidates priced in ? This short is, we confirm, mostly political. The fiscal numbers are terrible, but they are terrible in public. Everyone can read the 4.9% deficit and the €310 billion issuance program. What the market has not finished pricing is the politics that guarantee those numbers cannot improve before mid-2027, and can get worse faster than consensus assumes. Our motor is disbelief. Disbelief in rational budget negotiations this autumn, and disbelief in a presidential field where, of six likely candidates, four are bidding to spend more and only two, splitting the same electorate, propose anything a bondholder would call consolidation.

We are short via futures, DV01-neutral, short the OAT contract, long the Bund contract, isolating the French premium from the level of Euro rates. Target zone is 100-120bp into the spring, against a spread of roughly 80bp as we write. The horizon runs to the presidentials, April-May 2027, and maybe even beyond. This trade is all about the repricing of a political tail. We hold the position as of publication and will manage it without narrating the levels. The risks are real and specific, the biggest one being German, as Berlin's own fiscal expansion cheapens.

What France Claims vs Economic Reality

The official narrative survives every government that carries it. The deficit will decline towards 3% by 2029, growth will return to 1.4%, and the debt ratio will stabilize. The claim has been made annually since 2021 and missed annually since 2021. Reality, as of this writing, is that a 2026 deficit around 4.9% of GDP of which roughly 3.4 points are structural and primary, meaning France overspends before paying a cent of interest, at the highest tax take in the OECD, so neither lever has slack. Debt is near 116% of GDP and tracking towards roughly 130% by 2030 on current policy. The interest bill was €36 billion in 2020, is €59 billion in 2026, and the maths of rolling €300 billion a year of 1-2% legacy coupons into 4% money takes it towards €90 billion by decade's end whatever happens next. Growth printed 0.0% in Q1. Business failures set their fifth annual record, unemployment made its sixth consecutive quarterly rise to 8.3%, and youth unemployment sits at 21.6%, a figure we believe will climb with the new wave of fresh graduates.

The referees have spoken twice already. Fitch and S&P both cut France to A+ in the autumn of 2025, Moody's holds Aa3 with a negative outlook, and the 10-year OAT now yields more than Greece's, a comparison the connoisseurs will call unfair, Greek market debt being a sliver floating on an ocean of cheap official loans, and which we make anyway, because symbols are what the marginal buyer trades on. Politically, the Assemblée has burned through three governments since the 2024 dissolution, the 2026 budget passed only by 49.3 after two failed censure votes, and the price of the current government's survival was freezing the pension reform, the one structural saving of the past decade. The market story that remains to be broken is subtler than "France is fine", it is "France is priced." At 80bp over Bunds we think the chronic dysfunction is priced but the acute scenario is not.

Core Short Thesis

1. No majority exists to consolidate, and none can exist before mid-2027. The Assemblée elected in 2024 has censured one government, forced a second out, and left the third alive only by freezing pension reform. The 2027 budget arrives in late September into the same chamber, with the government already war-gaming early legislatives for March if it falls. Whatever is announced in the négociations, the passable subset is the 49.3 subset. Evidenced.

2. The presidential field is a fiscal loosening auction. Le Pen wants retirement back at 62 or 60 and VAT cuts on energy. Mélenchon publishes retirement at 60 and a chapter titled "Refuser le chantage : annuler la dette publique," proposing perpetual zero-coupon conversion of ECB holdings and a forced domestic treasury circuit. The PS wants back to 62. Attal would abolish the legal age criterion. Only Philippe and Retailleau propose restriction, and they are polling behind while splitting the same voters. Le Pen's ban was reduced on appeal in July, and the prediction markets make her the favorite at roughly 35%. To be exact about our sources, only Mélenchon's program is actually published. The rest we deduce from positions on record and from what each ran on in 2022, with the full manifestos due this winter, and manifestos rarely surprise in the direction of rigueur. The polls are public. Evidenced, with the caveat that programs are gross of parliamentary reality.

3. The macro-government loop is closing, and every leg spends. Defense goes to €64 billion in 2027, pulled forward two years, en route to €90-100 billion by 2035 under NATO commitments, announced as debt-free by a state running a 4.9% deficit. Pensions add a net 175-185 thousand beneficiaries every year, deaths replacing arrivals no earlier than the late 2030s, and the stock is inflation-indexed just as the energy shock revives inflation. Roughly a tenth of the OAT stock is itself inflation-linked, so the inflation that lifts ECB rates also lifts the interest bill directly. Unemployment is rising into the September graduate wave. Receipts have undershot forecasts two years running.

4. The captive buyer is the thesis's slow fuse. France places €310 billion of long-term paper a year, a record, into a market where the ECB no longer buys and foreigners hold roughly half the stock. The domestic backstop is the assurance-vie complex, €1.9 trillion of household savings recycled into OATs. It has held so far, and we watch it monthly, because a rotation of those flows abroad or into unit-linked products is the difference between a grind wider and a repricing. Partially evidenced, monitorable, honest about which.

5. External shocks reach the spread through France's fiscal plumbing. An oil or inflation shock hits France where Germany has no equivalent exposure, through the tariff shield the state re-arms every time energy spikes, through 14% of GDP of inflation-indexed pensions, and through the tenth of the OAT stock that is itself inflation-linked, so the shock converts into deficit before it converts into ECB policy. The market prices it that way. On daily data since the 2024 dissolution, the OAT-Bund spread has moved about 0.2bp for every 1% move in Brent and about 0.04bp for every 1% move in the VIX, both highly significant, while its sensitivity to the level of German yields is statistically zero. OATs are not really levered Bund. The beta to Bunds was 1.02 through the entire 2022 inflation shock and 0.98 in 2023, and on the largest Bund selloffs it falls to 0.74. OATs are a levered play on the shock itself, with this year the spread widening 22bp as Brent goes from 61 to 105, and on the pre-2026 coefficients oil accounts for roughly 10bp of it, the 66bp Bund selloff on its own would have compressed the spread by 7bp, and the remaining 9bp is French premium the market added on no macro news at all. The oil sensitivity was absent in 2022 and appeared only once France lost its majority. A fiscally credible issuer absorbs an energy shock but a fiscally paralysed one transmits it to its bondholders. Evidenced since mid-2024, shown by regime because the relationship is state-dependent.

The Country for Old Men

Here is why the title is not a joke. France has 17 million pensioners, the largest single budget item at about 14% of GDP, indexed to inflation, growing by the population of a mid-sized city every year. Pensioners vote at the highest rates of any cohort, and both political extremes are bidding for them with promises to retire earlier, while the only enacted reform that pushed the other way has just been suspended to keep a government alive. Nobody, on any ballot, touches indexation, which is where the money is. Meanwhile the young get 21.6% unemployment, a September job market that isn't hiring, and the invoice for all of the above, payable over their working lives through the highest taxes in the OECD or through the yield curve. The gérontocratie defaults quietly on the young while honoring the old, because that is what the median voter orders. The exit is possible with sub-index the largest pensions for a decade and channel the savings into a small mandatory funded pillar, the way Sweden did a generation ago. No candidate proposes it, which tells you the price of the exit is not economic. A pay-as-you-go state run for its retirees, borrowing 5% of GDP a year to keep the promise, is effectivement a country for old men. The bond market is where the (No) gets priced.

The Autumn, or Why We Doubt the Négociations

The 2027 budget bill lands in the Assemblée in late September, presented by a minority government to a chamber where the RN and LFI hold the censure trigger and the Socialists sell their abstention by the clause. The 2026 edition of this movie ended in February with two failed censures and a 49.3, after which the spread round-tripped from its highs. That precedent is the bear case for our entry and we respect it. The difference this time is that the budget must fund the accelerated defense ramp, a frozen pension reform, a rising interest bill and a social security deficit heading past €20 billion, all in the last full budget before the presidentials, when no party gains from moderation and every amendment is a campaign leaflet. We expect announcements wilder than consensus, from all sides, including surtaxes on corporates and the wealthy from the left, unfunded promesses from the right, and from the government whatever survives. Meanwhile the RN, refused by every French bank in 2012, 2017 and 2022 and again this cycle, needed the Prime Minister himself to convene six banks in July to broker a state-guaranteed syndicated loan, still unsigned as we write, while Le Pen leads the polls. The banks' reluctance tells you what probability the French establishment itself assigns to her presidency. No default is coming. What trades here is the price of political risk, offered today near 80bp and, we think, worth more in the spring.

The German Leg and Other Ways to Lose

Being short the spread means being long Bunds, and Bunds have their own politics. Germany is running its largest fiscal expansion since reunification, for rearmament and infrastructure, and every incremental €100 billion of Bund supply cheapens our long leg and compresses the spread with zero improvement in France. This is the trade's biggest external risk and it is entirely out of French hands. Shorting OAT futures outright would make us four-fifths a bet on the ECB in a hiking cycle driven by an oil shock we cannot forecast. The spread isolates what we actually have a view on. But we size for the possibility that Berlin out-issues Paris's deterioration, and a structural German supply shock that compresses the spread against the political calendar is a reason to reassess. The data put a number on it. On the 87 days since 2022 when Bunds sold off by more than 8bp, OATs moved only 0.74bp per Bund basis point, and the day Berlin announced its fiscal package in March 2025 the spread tightened by nearly 5bp while both legs sold off 25 to 30bp.

The other honest bull points, so the reader can mark us against them. The savings wall holds with households saving close to 19% of income and assurance-vie inflows remain strong, so the captive bid is still growing. Primary demand is fine, with auction bid-to-cover above 2 and no failed auctions, and this is the earliest falsifier in either direction. The snowball effect has not ignited because the average coupon on the stock, near 2.3%, still sits below nominal growth, and only the marginal rate exceeds it, so the crisis compounds on an 8-year fuse. The ECB's TPI exists, and although its conditionality reads awkwardly for a country in excessive-deficit procedure, we assume the ECB finds a way if fragmentation truly threatens. Defense may migrate partly to EU joint issuance, mutualizing the one spending line everyone agrees on. And the 2026 precedent cuts against us, i.e. maximum noise produced a budget anyway, and the spread gave back the entire panic. If censure fails again and a budget passes by 49.3 in December, we expect a retrace towards 70bp and we intend to still be positioned, smaller, for the spring, because the election does not care which technocrat signed the décret in February.

Catalysts, Timing, and Path

The calendar is dense, which is what today's 80bp buys us. Late September brings the 2027 budget bill and the AFT's full-size auction schedule after the summer lull. October through December is the censure window, overlapping the ratings calendar, where Moody's negative outlook is the live one. A cut to single-A at the third agency completes the set and tests every ratings-constrained mandate still holding OATs. A lost censure triggers the March early-legislatives scenario the government has already gamed out publicly, which is the fast path to the top of our target zone. Through the winter, campaign-finance headlines, candidate declarations, and the first serious runoff polls do the rest. n the post-dissolution coefficients every 10% move in Brent is worth about 2bp of spread in the same direction, and a risk-off week adds to it, so an energy or geopolitical flare-up does part of the politicians' work for us, and a calm winter in oil takes some of it away. The first round in April 2027 is the first decision point. By then the premium is either repriced, and we are sellers into the fear, or the center has consolidated, and we are wrong and gone. The uncertainty dies on election night, one way or the other.

Risks to the Short

The carry is against us, modestly, and ten months of it is real money if nothing happens. Carry and roll run against us at roughly 1 to 1.5bp of spread per month, the 80bp yield differential paid on equal DV01 plus rolldown on an upward-sloping spread curve, call it 10-15bp cumulated to the first round. The politics must clear that hurdle before the position earns its first basis point. The ECB can cut into a growth scare and rally everything semi-core in a way that flatters France's optics without improving France. A European defense-bond breakthrough would be spread-negative twice over, once by mutualizing French spending and once as a federalist signal. Philippe consolidating the center-right into a clear runoff favorite is the clean kill for the thesis, and we would respect it quickly. The widener is a consensus macro trade after two years of French headlines, and consensus trades squeeze hardest. What would confirm the thesis are a failed or tailed auction, a visible turn in assurance-vie flows, Moody's completing the single-A set, or any poll putting Le Pen and Mélenchon in the same runoff. The thing that would potentially break it is a budget passed by actual majority vote, or a candidate polling above 30% on a consolidation platform. We know which France we are betting on. We wish we were wrong.

Conclusion: Until It Won't

The wealth is real, the tax machine is at maximum efficiency, the savings pool is enormous, and the arithmetic of stabilization, three points of primary adjustment with pension indexation as the obvious instrument, is smaller than what half of Europe has already done. What France lacks is not capacity but a majority, and no majority can arrive before mid-2027 while every path to one runs through candidates promising to retire earlier and spend more. Until then the state borrows 5% of GDP a year to keep the gérontocratie's promise, the interest bill compounds towards €90 billion, and the only questions are the price of the risk premium and the speed of its repricing. We are short the spread, targeting 100-120 into the spring.

"If the rule you followed brought you to this, of what use was the rule ?"

Anton Chigurh, No Country for Old Men