Bond yield spreads at highest since 2011 as European markets steady

European stocks are holding relatively steady today; France's CAC 40 is even up by 0.3%. The euro has edged slightly lower against the dollar but stays above 1.1200, trading near 1.1215. That indicates that traders are not yet scrambling for the exits.

That said, the calmer mood should not be confused with an improvement in the underlying risks for European markets, especially when bond markets are flashing a different signal.

The spread between 10-year French and German bond yields has widened further to around 158 basis points, its highest level since 2011. The current reading mirrors levels from the peak of the Eurozone sovereign debt crisis.

That is not a comforting comparison, even if conditions have not yet fully matched those of the earlier crisis.

The wider spread shows investors are demanding a higher premium to hold French debt relative to German bonds. With France's fiscal troubles and political uncertainty showing few signs of easing, bond investors have little reason to feel more assured at this point.

What might come next?

It will be important to watch for signs that the situation could broaden beyond France. There may already be early indications of such a shift.

The yield gap between Italian and German 10-year bonds has also widened, to about 119 basis points, approaching the highs of 120-125 basis points from earlier this month. If this spread keeps climbing alongside the France-Germany spread, it would suggest growing investor caution about euro-area sovereign debt in general. That would mean the issue is no longer just a French one.

This is where the risk of wider market contagion starts to emerge. It could then put more pressure on European stocks and the euro and complicate the ECB's policy considerations.

For the moment, the calm in broader markets is a welcome respite. But attention should focus on developments beneath the surface. With yield spreads at risk of blowing out, the recovery in market sentiment could prove short-lived.