French President Francois Hollande never misses an opportunity to boast about his country’s record- low bond yields. Trouble is, they may have little to do with him or his policies.
Euro-area worries -- from Greece’s budget woes and a German court ruling on the region’s bailout fund to anti-austerity candidates gaining support ahead of today’s Dutch vote -- have sent investors scurrying to the relative safety of French debt. Investors drove yields below zero at a French bills sale last week and pushed 10-year borrowing costs to 2.21 percent, the lowest at an auction since at least 1999.
“What’s keeping French yields low is event risks ahead: Greece is still an issue; the German Constitutional Court’s decision is a risk; and we have an election in the Netherlands,” said Michael Leister, a strategist at Commerzbank AG in London. “France still offers safety in this environment. Hollande is working on reforms and that’s important, but it’s the situation in the euro region more than anything French specific that gets French yields to these levels.”
Hollande faces an economy that hasn’t grown in three quarters and joblessness is at a 13-year high. The French president is also struggling to plug a budget hole of more than 30 billion euros ($37 billion) for next year.
“The state borrows on the market at rates that are historically low,” he said in an interview on TF1 Television on Sept. 9. “But can we be sure it will last? I’m proud that France is among countries that has the capacity to borrow at such low rates, but we can’t just bank on this situation.”
The French 10-year yield was at 2.2 percent today, about 20 basis points higher than the record-low reached on Aug. 3 and down from 2.89 percent on the last trading day before Hollande’s election on May 6.
While France was stripped of its AAA rating for the first time this year by Standard & Poor’s, since the end of June its bonds have outperformed those of euro-area countries with the top credit ranking.
French government securities returned 3.1 percent in the period, beating 0.6 percent for German bunds, Finland’s 1.5 percent and 1.4 percent for the Netherlands, according to Bank of America Merrill Lynch data.
Investors were lured by France’s stability relative to countries such as Spain and Italy in Europe’s so-called periphery and reassured by Hollande’s consistent reiteration of his goal to cut the budget deficit to 4.5 percent of gross domestic product this year and 3 percent next year from 5.2 percent in 2011.
“France wins out by default,” said Gareth Fielding, chief investment officer at Quantum Global Wealth Management in Zug, Switzerland, which manages about $6 billion. “We are buying French securities not because we love French fundamentals; Hollande’s trying to meet his deficit target by raising taxes, but he will miss his growth target doing that. We buy French bonds because yields in the core market are so low, and we are not willing to accept the high risk of Italy or Spain.”
The French bonds rally came as the European Central Bank cut its main interest rate to a record low and reduced its deposit rate to zero as the euro area teetered on the verge of recession and Spanish and Italian 10-year bond yields climbed above 6 percent. Then on Sept. 6, ECB President Mario Draghi set out a plan to aid countries where bond yields have soared after leaving interest rates unchanged at the record-low 0.75 percent.
The ECB will acquire unlimited amounts of bonds with maturities of as much as three years, issued by nations that request aid from the European Union’s bailout funds. The central bank also gave up seniority over other investors in a default.
The moves helped cut the Spanish 10-year yield to about 5.7 percent and the Italian one to 5.1 percent.
They may also have made France the “eurozone’s Teflon bond market,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London.
“France’s sovereign debt market has entered something of a sweet spot,” he said. “It has benefitted as much from bouts of risk aversion towards Spain and Italy as it has from periods of increased risk appetite.”
Hollande’s insistence that France will stick to its deficit-cutting targets is aimed at staying in that spot.
On Sept. 9, Hollande gave himself a two-year window to fix the economy as he announced a freeze in government spending and 30 billion euros in deficit-reduction measures to be included in next year’s budget to reach his fiscal targets.
He also cut the 2013 growth forecast to 0.8 percent from 1.2 and announced measures including 10 billion euros in spending curbs, 10 billion euros in corporate taxes and 10 billion euros in levies on individuals.
For now, investors are “giving Hollande the benefit of the doubt,” said Nick Stamenkovic, a fixed-income strategist at RIA Capital Markets in Edinburgh. That may not last if Hollande is unable to revive the economy, he said.
The premium France pays over Germany to borrow for a decade, which fell below 60 basis points for the first time in more than a year on Aug. 15, was at 58 basis points today.
“The spread suggests investors still have some confidence that Hollande will stick to his fiscal consolidation pledge,” Stamenkovic said. “He hasn’t committed any major political mistakes and that works for him with the investment community.”
The real test will be the budget for next year, he said. French Prime Minister Jean-Marc Ayrault is set to present the 2013 budget the week of Sept. 24.
“The market will want to look at the details of the budget,” Stamenkovic said. “The risk is that the weakness of the French economy could prompt renewed worry that France may miss its target, and we can see a backup in French yields.”
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