Spanish bonds dropped following a rally yesterday when the European Central Bank unexpectedly cut its key interest rate to counter a risk of deflation. S&P downgraded France to AA from AA+ with a stable outlook saying the government’s reform of tax, labor markets, products and services won’t raise medium-term growth prospects. The cost of insuring French debt against default fell to the least in more than three years. Benchmark German bunds were little changed.
“French yields rose slightly after the downgrade but we expect any increase to be limited as the move has been largely expected,” said Ciaran O’Hagan, head of European interest-rate strategy at Societe Generale SA in Paris. “The news may have provided some impetus for the market to take profits on Italian and Spanish bonds after a big rally yesterday. But in the bigger scheme of things, the impact will probably be limited.”
The yield on France’s 1.75 percent bond due in May 2023 increased three basis points, or 0.03 percentage point, to 2.18 percent at 1:05 p.m. London time. The price dropped 0.21, or 2.10 euros per 1,000-euro ($1,343) face amount, to 96.305.
The French government-bond market is the second biggest in the euro area, trailing only Italy, and is the fourth largest among global sovereign-debt markets, according to data compiled by Bloomberg.
Credit-default swaps on French debt fell one basis point to 51.4 basis points today, the lowest since April 2010, based on closing prices. That compares with a euro-era high of 253 basis points set in November 2011.
A basis point on a credit-default swap protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.
A report today showed industrial production in France unexpectedly dropped 0.5 percent in September from August when it expanded 0.7 percent. The median of 17 estimates in a Bloomberg News survey was for a 0.1 percent gain.
Fitch Ratings Ltd. stripped France of its AAA ranking in July, after Moody’s Investors Service reduced it to Aa1 from Aaa in November last year. Investors have largely shrugged off those announcements.
Since S&P’s first downgrade on Jan. 13, 2012, French government bonds returned more than 10 percent, according to Bloomberg France Sovereign Bond Index. (BFRA)
“In part this reflects a diminished power to shock on the part of ratings agencies since the global crisis began,” said Richard McGuire, head of European interest-rate strategy at Rabobank International in London. “It’s central bank liquidity that has been in the driving seat in terms of determining the euro-zone yield and spreads. This is why the ever popular notion of shorting France versus Germany has remained very much the pain trade despite the convincing fundamental arguments.”
Spanish 10-year yields increased one basis point to 4.06 percent. The rate dropped 10 basis points yesterday, the biggest decline since Oct. 1. The yield on similar-maturity Italian bonds was little changed at 4.09 percent after falling to 4.04 percent yesterday, the lowest since May 28.
Italy may reduce its government-bond issuance plan for the rest of the year, debt agency chief Maria Cannata said at a conference in Brussels today.
The Frankfurt-based ECB, led by President Mario Draghi, reduced its main refinancing rate by 25 basis points to a record-low 0.25 percent yesterday. The decision was predicted by three of 70 economists in a Bloomberg News survey. Officials kept the deposit rate at zero and lowered the marginal lending rate to 0.75 percent from 1 percent.
Germany’s 10-year bund yielded 1.70 percent after sliding to 1.65 percent on Oct. 31, the lowest since Aug. 8.
The extra yield investors demand for holding French bonds maturing in May 2023 over German securities due in August 2023 widened by two basis points to 49 basis points. The average spread over the past five years, based on their generic yields, is 69 basis points. The yield difference may widen further in the near term, according to BNP Paribas SA.
“Typically, France tightens after a rating-agency downgrade, which is unlikely to us this time,” BNP Paribas analyst Eric Oynoyan wrote in a research note. “We think France is vulnerable to a spread widening not because of the downgrade but on the contrary, because valuation has become too expensive recently.”
Volatility on German bonds was the highest in the euro-area markets today, followed by those of Finland and Belgium, according to measures of 10-year debt, the yield spread between two- and 10-year securities and credit-default swaps.
French securities gained 0.3 percent this year through yesterday, according to Bloomberg World Bond Indexes. Spain’s returned 11 percent, Italy’s earned 7 percent, while German bonds lost 1 percent.