The premium investors demand to hold French bonds instead of German debt rose to its highest since late 2012 on Monday after a poll showed the far-right Marine Le Pen narrowing the gap with centrist opponents in the race for the French presidency.
Renewed selling in French bonds rippled through euro zone bond markets, helping to push yields on short-dated, safe-haven German bonds to a record low, although the impact faded as the day wore on.
A poll released on Monday showed Le Pen 16 points behind centrist Emmanuel Macron, down from 20 points previously for a potential second-round run off scheduled for May. Le Pen was 12 points behind conservative candidate Francois Fillon, from 14 points previously.
Le Pen is expected to win in the first round, in April, and investors are concerned about her anti-euro stance, among other factors.
Justin Solomon | CNBC
France's 10-year bond yield rose as much as 9 basis points to a two-week high at 1.14 percent, before settling back to 1.05 percent as markets closed.
Benchmark German Bund yields were pinned near 0.29 percent, with the spread to French equivalents at one stage around 84 bps - the biggest gap since late 2012.
"It all seems to be driven by the move in French bonds after a poll that showed Le Pen's improving fortunes in the second round of voting," Rabobank strategist Lyn Graham-Taylor said.
Two-year German bond yields hit a record low at minus 0.85 percent, while other euro zone bonds sold off with their French peers. Irish and Italian 10-year bond yields briefly rose as much as 7 bps each.
Markets are also uneasy about a possible agreement between French Socialist candidate Benoit Hamon and hard-left candidate Jean-Luc Melenchon, which could strengthen Le Pen.
In addition to French political jitters, other developments in the bloc kept investors on their toes.
In Italy, former prime minister Matteo Renzi resigned as head of the ruling Democratic Party on Sunday, opening the way for a leadership fight in which he will take on rivals threatening to split the center-left.
And in the Netherlands, anti-Muslim, anti-EU party leader Geert Wilders began his election campaign on Saturday, promising to crack down on "Moroccan scum" whom he said were making the streets unsafe. Dutch voters go to the polls on March 15.
"It's a hard to see a political risk premium in Dutch bonds, but the importance of the Netherlands is the implications it has for elsewhere," said ING senior rates strategist Martin van Vliet. "Any populist win in the Netherlands would increase the likelihood of gains in other parts of the euro zone."
Greek two-year bond yields dropped more than 50 basis points to 9.37 percent after a Greek government official said the country had agreed with euro zone finance ministers to resume negotiations over its bailout review.
The official said technocrats representing the lenders would return to Athens immediately after Feb. 27 with a view to concluding a staff level agreement within a few days.
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