European equities are keeping steadier so far today with France's benchmark CAC 40 index even holding up by 0.3% on the session. Meanwhile, the euro is also only slightly lower against the dollar but is still holding above the 1.1200 level at around 1.1215 currently. That suggests traders are not quite rushing for the exits just yet.

That being said, I wouldn't be too quick to mistake the calmer mood for an improvement in the underlying risks for European markets. Not especially when the bond market is hinting at a different mood.

The France-Germany 10-year yield spread has widened further to around 158 bps today, marking its highest level since 2011. And if you look at the chart, we're now revisiting levels last seen during the height of the Eurozone sovereign debt crisis.

That's hardly a reassuring comparison, even if we are not quite talking about a repeat of those very same circumstances just yet.

In any case, the widening spread reflects the growing premium investors are demanding to hold French debt over German bonds. And with France's fiscal troubles and political uncertainty showing little signs of easing, there isn't much reason for bond investors to feel more comfortable at this stage.

So, what's next from here?

It will be important to watch out for any concerns about how this story could develop into something that is not just France anymore. And we might already be getting some early hints of that.

The Italy-Germany 10-year yield spread has also widened to nearly 119 bps today, threatening to retest the highs around 120-125 bps seen at the start of this month. If that spread continues to push higher alongside the France-Germany spread, it would suggest that investors are becoming more cautious about euro area sovereign debt more broadly. In other words, the story is starting to become more than just a French one.

That is where the risk of wider market contagion starts to creep into the picture. In turn, that could potentially weigh more heavily on European equities and the euro while complicating the ECB's policy outlook.

For now, the calm in broader markets is a welcome relief. However, I would be paying much closer attention to what is happening beneath the surface. With yield spreads at the risk of blowing up, there's every risk that this recovery in market sentiment could be a short-lived one.

This article was written by Justin Low at investinglive.com.

Source: Investing Live - News