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Sarkozy’s Yield Drop at Risk With Hollande Victory

Sarkozy’s Yield Drop at Risk in Hollande Victory
French President Nicolas Sarkozy. Photographer: Jock Fistick/Bloomberg

French Socialist candidate Francois Hollande is proving more successful than President Nicolas Sarkozy at wooing voters ahead of next month’s election. Bond investors are less impressed.

Hollande, who has led Sarkozy in polls conducted during the past year, has promised to reverse the incumbent’s plan to raise the sales tax and reduce the cost of labor for employers. He also wants to renegotiate the fiscal pact agreed by Germany, France and other European countries in December.

“A Hollande victory would probably be a negative for French debt,” said Peter Allwright, who helps oversee about $4 billion as head of absolute rates and currency at asset manager RWC Partners in London. “I can’t see it being a good thing.”

The premium France pays to borrow over Germany has dropped by 50 percent since it reached a two-decade high in November. The spread narrowed as yields on 10-year French bonds slid to 2.999 percent from 3.722 percent on Nov. 24. The decline occurred even after Standard & Poor’s stripped France of its AAA rating in January.

Efforts on the European sovereign debt crisis by Sarkozy and German Chancellor Angela Merkel, whose close ties led to the coining of the term “Merkozy,” may falter if Hollande wins, and spreads may “widen across the board,” said Myles Bradshaw, a fund manager at Pacific Investment Management Co.

“The strength of the relationship between the two leading governments in the euro zone, France and Germany, and their ability to work together” may be thrown into question by a Hollande victory, Bradshaw said on Bloomberg Television’s “The Pulse” show in London on March 14.

Merkel Ties

“People are not sure what kind of balance Hollande and Merkel will find,” said Christian Borjesson, an analyst at Nordea Markets in Stockholm. “If Hollande wins, it could create some market volatility. From a market perspective, it will be much more negative if Hollande wins.”

France paid costs of 2.4 percent in weighted average terms in the first two months of this year as it raised 39.6 billion euros ($53 billion), or 22 percent of the 178 billion euros it needs for 2012, said Philippe Mills, chief executive officer of Agence France Tresor, the nation’s debt agency, said in an interview last month. That compares with 2.8 percent in 2011 and a record low 2.5 percent in 2010.

France was cut by one level to AA+ by S&P on Jan. 13. As with the U.S., which lost its AAA rating in August, investors in French bonds shrugged off the downgrade.

Debt Auction

French borrowing costs fell yesterday when the Treasury sold about 10 billion euros of debt. The yield on the benchmark five-year bonds was 1.78 percent at the auction, down from 1.93 percent on Feb. 16.

The decline has largely been driven by the European Central Bank’s Long Term Refinancing Operation, which has made 1.02 trillion euros of three-year loans available to banks across the region since December.

Sarkozy had pressed the ECB for much of last year to take a bigger role in the crisis-fighting effort, an idea opposed by Germany. After months of wrangling, Sarkozy and Merkel agreed on Nov. 24 to stop debating the central bank’s fire-fighting role.

Two weeks later, the ECB said it would offer unlimited cash to banks at 1 percent for three years and ease its collateral rules. On Dec. 9, Sarkozy advocated that banks use some of those funds to buy sovereign bonds, prompting some investors to call such transactions the “Sarko trade.”

Opinion Polls

Market attention may “begin to switch to the French election,” said John Davies, a fixed-income strategist at WestLB AG in London. “Although Hollande has been leading in opinion polls, the market may be thinking that the recent tentative signs of recovery in France mean that a Sarkozy victory cannot yet be ruled out.”

The first round of the French election will be held on April 22, with the two winners squaring off in the decisive second round on May 6.

Although France avoided a recession in the fourth quarter, Sarkozy has been dogged by a slowdown in Europe’s second-largest economy that set in as concern about the sovereign debt crisis mounted. With the economy stalling, French jobless claims rose in 2011 to a 12-year high.

In French politics, Hollande has been the main beneficiary. The Socialist candidate would win 54 percent of the vote if the second leg of the two-round election were held now, compared with 46 percent for Sarkozy, according to a CSA poll for BFMTV, RMC radio and 20 Minutes that was published yesterday.

‘Risk Premium’

The possibility of an Hollande win would mean “you have to build in some kind of risk premium,” Jim O’Neill, chairman of Goldman Sachs Asset Management, said in a Bloomberg Television interview today. “That said, there is a lot of evidence flying around, based on history, that once he gets into the second round, we might find out that he’s not quite so aggressive” about things that worry investors, O’Neill said.

Meanwhile, the economic outlook and unemployment are the two biggest voter concerns, according to an Ipsos-Logica poll published March 1. The survey showed that 60 percent of voters believe Hollande is best capable of reducing unemployment, compared with 37 percent for Sarkozy.

Hollande says he’ll meet Sarkozy’s goal of reducing the deficit to 3 percent of gross domestic product by next year from 5.3 percent last year. He says he wants to create a government bank to finance small businesses and to target support for specific industries rather than an across-the-board cut in employers’ contribution to state-managed family allowances.

Political Posturing

Sarkozy is proposing a 13-billion euro cut in payroll charges, to be funded with a higher value added tax, to boost French competitiveness after the country’s trade gap widened to a record 69.6 billion euros last year.

“There’s uncertainty about what Hollande’s proposals are for reforming France to make sure France can remain competitive,” Pimco’s Bradshaw said. “It clouds the picture about what France is really doing in terms of its structural reforms to enable it to grow the economy.”

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