Rates markets were highly volatile. 10-year US Treasury yields hit a 24-year high before retracing sharply. Concerns over France’s fiscal outlook drove a broader sovereign bond sell-off. The US dollar strengthened

The Bond Market Just Knocked on the Door

Well, Stuart, this morning's report certainly caught my attention - particularly because it was only yesterday that I did a fairly deep dive into the balance sheets of the major French banks, prompted by the rapidly deteriorating French sovereign position.

What bothered me yesterday was remarkably simple - forget the comforting regulatory alphabet soup for a moment and ask how much actual shareholders' equity sits underneath these enormous balance sheets.

At BNP Paribas, roughly €138 billion of shareholders' equity supports more than €3.08 trillion of assets - around 4.5%. Société Générale is not greatly different, with total equity of roughly 4.8% of assets, or nearer 4.3% if equity attributable to the group is used.

In plain English, we are looking at something approaching €20-€23 of assets sitting above every €1 of accounting equity. That does not mean these banks are insolvent, nor does it mean that a fall in French government bonds translates dollar-for-dollar into losses against bank equity. Duration, hedging, accounting classification and the composition of their securities portfolios are important too.

But this morning's numbers suddenly make the exercise rather less academic - Stuart reports the French 10-year spread over Germany blowing through 140 basis points, having been around 100 only a fortnight ago, while European bank shares were simultaneously being hit.

And this is occurring with French public debt around 119% of GDP, roughly €3.6 trillion, while the sovereign faces another enormous refinancing requirement as the cheap debt issued during the pandemic and energy crises progressively matures.

This is where I think we need to look beyond the daily market explanation. France increasingly has the ingredients of the old sovereign-bank feedback loop sitting in plain sight.

The sovereign's funding cost rises. Existing bonds reprice lower. Refinancing becomes progressively more expensive. Government interest costs rise. Fiscal room contracts. Banks hold sovereign securities directly and indirectly throughout the collateral system, while simultaneously being exposed to the domestic economy that fiscal deterioration ultimately affects.

And sitting underneath all of this are enormous bank balance sheets supported by surprisingly thin layers of actual equity.

Interestingly, the market itself appears to be noticing. Credit-default-swap spreads on BNP Paribas, Société Générale and Crédit Agricole have recently risen much more sharply than the broader European banking measure.

But perhaps the most fascinating number in Stuart's report isn't French at all - the US 2-year yield fell around 10 basis points while the 10-year briefly exploded to 5.34%.

That is hardly a straightforward story about markets suddenly expecting the Fed to tighten aggressively. The short end was simultaneously backing away while the long end demanded substantially more compensation.

That brings us straight back to what I have been banging on about for some time - who is going to be the marginal buyer of this extraordinary volume of sovereign debt, and at what price?

The US has its gigantic refinancing requirement and fiscal deficit. France has its own increasingly uncomfortable refinancing arithmetic. Other European sovereign spreads are widening. 

Japan is dealing with its own bond-market pressures. And governments everywhere are discovering that debt accumulated when money cost virtually nothing doesn't disappear when interest rates normalise - it eventually has to be rolled over.

That is where this becomes structural rather than simply another volatile morning in the markets - and it is precisely why yesterday's exercise looking at actual bank equity rather than merely regulatory risk-weighted ratios is so critical.

#1 A French bank having 4-5% balance-sheet equity is not, by itself, evidence of a crisis.

#2 A French sovereign spread blowing through 140 basis points is not, by itself, evidence of a crisis either.

#3-6 Nor is a falling euro, rising bank CDS, weakening bank equities or a government refinancing hundreds of billions of euros of debt at progressively higher yields.

But put all of those pieces on the same table and suddenly the picture becomes considerably more interesting.

It was just yesterday I was looking at the dodgy foundations, and this morning the bond market gave them quite a shake.