Federal Reserve Governor Kevin Warsh did not send a signal of an interest rate hike in October, so market expectations shifted to December, even though borrowing costs in France and credit risks related to artificial intelligence are both on the rise. Stephen Coltman, the macro director at 21shares, pointed out in a comment on October 19 that there is a stark contrast between the decline in U.S. Treasury yields, the increasing debt pressure in France, and the widening credit spreads of highly indebted AI companies.

Key Points

• The market once again expects the Federal Reserve to remain inactive at the end of October, with any potential interest rate hikes being postponed until December.
• The lending premium of France relative to Germany is approaching 150 basis points.
• The credit spread of Oracle is moving closer to the level of high-yield bonds.

Warsh does not release signals; market expectations for the Fed's interest rate hike shift to December

Coltman writes that, after Kevin Warsh did not send any signals indicating a readiness to welcome investors in light of the upcoming interest rate hike, the market expects the Federal Reserve to keep interest rates unchanged at the end of October. The possibility of a rate hike has been postponed to December 2026.

A week earlier, the core inflation figure released by CPI exceeded expectations, which led the market to bet that another interest rate hike would be announced at the FOMC meeting in October. However, during a public interview during the IMF meeting, Warsh did not reinforce this possibility, and that was also his last public appearance before the Fed's quiet period.

It is anticipated that Federal Reserve officials will not make any further public statements before the meeting scheduled for the end of October.

As U.S. yields fall, France's debt pressure intensifies

Coltman indicates that French government bonds are diverging from those of other major developed markets, with the yield spread of 10-year OAT bonds relative to German government bonds approaching 150 basis points. Since the beginning of October, the yield on 10-year US government bonds has fallen by about 20 basis points, while the yield on French bonds has continued to rise.

On October 19th, the yield on 10-year French bonds soared by more than 10 basis points, while the yields on 2-year and 30-year bonds increased by 6 and 8 basis points respectively. During afternoon trading, the CAC 40 index fell by 1.7%. France's benchmark borrowing cost reached its highest level since 2002.

Political uncertainty and difficult budget negotiations have further increased the pressure. The minority government led by Prime Minister Sé bastien Lecornu is facing resistance in passing the 2027 budget, which includes proposed spending cuts of 54 billion euros. Last year, France's deficit accounted for 5.1% of GDP; the government's goal is to reduce it to 5% and plans to bring it down to 3% by 2029.

The Governor of the Bank of France, Emmanuel Moulin, stated on October 15th that it is political uncertainty, rather than changes in the fiscal situation, that is driving up borrowing costs. He mentioned that debt repayments increase by about 10 billion euros each year, making fiscal consolidation more difficult. However, he still described the French financial system as having sufficient capital and good liquidity, and noted that France does not face difficulties in attracting bond buyers. KBRA, a senior director at the sovereign rating agency, also mentioned that the underlying demand was strong during last week's auctions.

Coltman takes a more cautious view. He believes that it is unlikely for the sovereign debt crisis to stabilize before it worsens further. He thinks that unless the pressure threatens the stability of the eurozone bond market, there is little likelihood of the European Central Bank (ECB) intervening. Sharon Bell, Goldman Sachs' European equity strategist, also stated that the current situation is not sufficient to trigger an emergency intervention, but if market liquidity is disrupted, the ECB should use its transmission protection tools (Transmission Protection Instrument).

Coltman believes that Marine Le Pen's chances of winning in the 2027 presidential election have increased, which could lead to structural tensions in Europe, especially considering her willingness to unilaterally reduce France's contribution to the EU budget.

AI Expenditure Tests and the Continuously Widening Credit Spread

Coltman writes that investors are paying attention to the financial reports of Meta and SpaceX, as well as the public information of Anthropic IPO, in order to find clues regarding the investment expenditures of AI. At the same time, the widening credit spread is exposing the vulnerabilities of high-debt AI related companies.

He believes that these companies are particularly vulnerable to the impact of a slowdown in demand for AI. The situation with Oracle is particularly prominent: its five-year CDS yield spread has widened significantly, and now its trading level is closer to that of high-yield bond issuers rather than investment-grade issuers.

Coltman warns that if Oracle is downgraded to the speculative category, given its total debt scale, it will become by far the largest issuer of high-yield bonds. Such a scenario would absorb a large amount of available capital and could squeeze smaller borrowers. His judgment is in regard to the potential downgrade; the change in the credit market he mentions is the sharp widening of the Oracle CDS yield spread.

This article was generated with the assistance of artificial intelligence and has been reviewed by an editorial team.