When the political world shakes, so does the bond market. After French President Emmanuel Macron called a surprise parliamentary election that might have placed the far-right in power, the gap, or spread, between the yield on French and German government bonds reached its highest level since 2012. Some feared a meltdown in the bond market to rival Liz Truss’s “mini” Budget. As it happened, none of the voting blocs were close to a majority and the far-left is in the lead.
Both the annual interest payment and the repayment value of these bonds is linked to an inflation index . Oddly, when inflation surged in 2022, index-linked gilts performed terribly. The reason was that pension funds had been huge buyers of these gilts as they were seen as the ideal way of meeting their promise to pay retirees an income that rose in line with inflation. This pushed up the price of the bonds so they offered a real yield that was negative.