French Bond Yields Test Hollande’s Economic Fealty

French Election Frontrunner Francois Hollande
French election frontrunner Francois Hollande. Photographer: Fred Dufour/AFP/Getty Images

Investors are steering away from French bonds as they cast a wary eye on election frontrunner Francois Hollande’s calls to ease austerity.

French government debt ranked as the third-worst performer in Europe this month after Spanish and Italian securities as of yesterday, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. The decline in French bonds occurred in anticipation of Hollande winning the first round of balloting against President Nicolas Sarkozy on April 22, which he did.

“It’s not time to buy French bonds,” said Tom Elliott, a global strategist at JPMorgan Asset Management in London. “The bond market is still uncertain just how Socialist Hollande will turn out to be, or whether he will turn out to be a fairly centrist president.”

For Hollande, who leads in the polls for the decisive May 6 final round against Sarkozy, the jittery markets show investors want to be reassured of his commitment to economic rigor in the face of signs of crisis fatigue in Europe and at home. Hollande plans to reverse Sarkozy’s plan to raise the sales tax and cut labor costs. He also wants to renegotiate the euro area’s so-called fiscal pact to include a commitment to growth.

A 1.2 percent loss puts French bonds in the same league this month as Greek bonds, which declined 1.1 percent. The premium France pays over Germany to borrow for 10 years climbed to 141 basis points today, up from as little as 95 basis points five weeks ago. In the period, yields on 10-year French bonds rose to 3.1 percent from 2.9 percent.

Finding the Center

The cost of insuring French government bonds against default is at the highest level since the start of the year. Swaps cost on French debt rose to 207 basis points earlier today, compared with 222 basis points at the start of the year and up from 156 last month.

Hollande got 28.6 percent of the vote in the first round of France’s presidential election on April 22, leaving him to face Sarkozy in next month’s runoff. Sarkozy won 27.2 percent.

“If we win, France will re-focus European construction and put industry and sustainable growth at the center and Europe will revive,” Hollande said in a speech in Brittany yesterday. “It will be the end of imposing austerity everywhere, austerity that brought desperation to people everywhere in Europe.”

The possibility of Hollande edging toward the center has strengthened with the weaker-than-expected score in the vote by Communist-backed Jean-Luc Melenchon, who immediately endorsed Hollande for the second round. A strong showing for Melenchon might have pushed Hollande further from the center.

“In the second round of a French election, the battle is for the center,” said Laurent Dubois, a professor at the Institute of Political Studies in Paris. “For Francois Hollande, there is nothing to lose on the left.”

Moderate Tone

“The market is already pricing in the possibility of him winning the election,” said Charles Diebel, head of market strategy at Lloyds Banking Group Plc. “Many people expect him to moderate his tone on what he actually does when he gets into power. That’s the hope, but I’m not convinced.”

Hollande, 57, has promised to slash France’s budget deficit to 3 percent of gross domestic product next year and to eliminate it by the end of the next presidential mandate in 2017. He wants to hire 60,000 teachers and public school employees and 5,000 police officers over the next five years, pull back the retirement age to 60 from 62 for some people, and also rework the fiscal treaty agreed to by European leaders in December to focus on economic growth.

“You can argue that growth is what Europe needs,” Diebel said. “But growth via fiscal spending or lack of fiscal austerity can be a dangerous game to play in the world where credit and credit evaluation increasingly matters.”

Poll Gains

Sarkozy, 57, has been dogged by a slowdown in Europe’s second-largest economy as countries across the region were hurt by a debt crisis that started in Greece. With growth stalling, French jobless claims rose in 2011 to a 12-year high.

In politics, Hollande has been the main beneficiary, gaining the support of 53 percent to 56 percent of French voters, while Sarkozy’s backing is at 44 percent to 47 percent, recent polls show. The surveys were conducted after first round voting ended by pollsters CSA, BVA, Ifop and Ipsos.

With the effect of the European Central Bank’s 1 trillion-euro ($1.31 trillion) liquidity injection fading and signs that turmoil in European sovereign debt markets are returning, Hollande will have little room to maneuver if he does win.

“It is not unusual that politicians promise one thing going into the election and then do the opposite afterward,” said Steven Major, head of fixed-income research at HSBC Holdings Plc. in London. “I think Hollande will stick to his rhetoric for now. He doesn’t want to risk losing support. There is a risk that people in the market are overstating their concern.”

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