European bond markets stabilise as hedge funds navigate French debt turmoil

European government bond markets regained some stability at the end of a volatile week, as easing oil prices and a pause in fresh developments in France helped calm investor concerns over fiscal risks and shifting hedge fund positions, according to a report by Bloomberg.French government bonds were on track for their first weekly gain in six weeks, while Italian debt was heading for its first advance in nine weeks. Yields across the region declined as Brent crude prices retreated towards $100 a barrel, following sharp fluctuations earlier in the week that saw French 10-year yields fall by as much as 16 basis points before rising 18 basis points on successive days.The recovery reflects improving confidence as political and fiscal concerns in France temporarily eased, while European Central Bank President Christine Lagarde reassured officials that the central bank had the tools to address unjustified and disorderly market movements. Oil prices also fell after US President Donald Trump said he would postpone further strikes on Iran until after November's midterm elections.The additional yield investors demand to hold French government debt rather than German bonds narrowed by three basis points to 137 basis points. Meanwhile, expectations for further ECB monetary tightening eased, with interest-rate swaps pricing in 72 basis points of increases by the end of next year, compared with 75 basis points on Thursday.Despite the improvement, investors remain wary of France's fiscal outlook. The premium required to hold French bonds over Italian debt has reached its widest level since the euro's creation, highlighting continuing concerns about French sovereign risk.The report cites Mohit Kumar, chief economist and strategist for Europe at Jefferies, as saying that hedge funds were likely to use any bond market rally to increase short positions, while longer-term investors remained reluctant to return until conditions became more stable.Kumar said he remained short on French government debt, arguing that the central concern was not an impending sovereign crisis or the prospect of a debt restructuring, but the risk of insufficient investor demand for French bonds.He added that French yields would need to rise to around 200 basis points above German equivalents before the ECB was likely to move beyond verbal assurances to more substantive intervention.France's debt management agency announced on Friday that it planned to sell up to €12bn of medium-term bonds at an auction scheduled for the following Thursday, placing further attention on investor demand for French sovereign issuance.