France's 10-year yield rises to five-month high amid political uncertainty

France's 10-year yield hit its highest since March on Tuesday and the gap with its Italian equivalent dropped below 10 basis points after French main opposition parties said they would not back the prime minister in a confidence vote. The spectre of renewed political instability in France added to worries in global bond markets about the independence of the U.S. Federal Reserve, which contributed to selling in government bonds from the U.S., Britain and Japan.

Germany, however, saw safe haven inflows, and its 10-year yield fell 2.6 basis points to 2.73%. France's 10-year bond yield rose as high as 3.53% in early trade - its highest since March and extending Monday's 7-bp rise. It was last 1.7 bps higher on the day at 3.50%.

French stocks also fell as Prime Minister Francois Bayrou looked set to lose the confidence vote announced for September 8 over his plans for sweeping budget cuts. Bayrou said lawmakers must now choose between "chaos" and "responsibility," and urged the French to pressure their representatives to make a prudent choice.

European ratings agency Scope sees a French government collapse as the most likely outcome. The gap between French and German 10-year yields, a gauge of the premium investors require to hold riskier French debt, jumped to more than 79 bps at one stage on Tuesday, its highest since April. It was last at 76.6 bps.

The gap between French and Italian spreads, which was more than 150 bps just two years ago, briefly narrowed below 10 bps. It was last at 11 bps. "We see increased volatility and pressure on French spreads in the coming days. One of our core positions has been to be short France versus Italy, and we maintain the view," said Mohit Kumar, chief European economist at Jefferies.

Events in the United States were also in focus after U.S. President Donald Trump said on Monday he was firing Federal Reserve Governor Lisa Cook over alleged improprieties in obtaining mortgage loans - a step that could test the boundaries of presidential power over the central bank. Cook responded several hours later in a statement saying of Trump that "no causes exist under the law, and he has no authority" to remove her from the job.

"Trump's move to oust Fed's Cook would be seen as another attempt at political interference. Any loss of credibility for the Fed should also be a steepener along the curve," said Kumar. Yield curves steepen when longer-dated bond yields rise more than shorter-dated ones.

Italy's 10-year yield edged 1.2 bps lower at 3.60%.

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