Hollande Honeymoon Brings France Record-Low Yields

French President Francois Hollande
French President Francois Hollande. Photographer: Michele Tantussi/Bloomberg

France is weathering renewed turmoil in Europe’s debt markets with record-low borrowing costs.

Higher rated than Spain or Italy and offering better returns than German securities, France finds itself in a sweet spot, drawing the strongest auction demand since the European debt crisis began in 2009 as bond investors give Francois Hollande, the country’s first Socialist president in 17 years, the benefit of the doubt.

“France has certainly shown some degree of resilience and recent auctions have gone well with strong demand from French domestic investors,” said Richard McGuire, a senior fixed-income strategist at Rabobank International in London. “Markets are approaching Hollande with a degree of caution but no discernible alarm. His rhetoric before the election has been taken with a pinch of salt.”

France’s 10-year bond yields 2.74 percent, the lowest since Oct. 10 and down from 3.17 percent before the April 22 first round of the presidential vote. The extra yield, or spread, investors demand to lend to France rather than Germany has declined even as German yields tumbled to a record low. The French-German spread was 135 basis points today from as high as 149 points on April 20.

French bonds have outperformed their Spanish and Italian counterparts since the first round of the election as the resurgence of euro-region’s debt crisis boosted demand for the relative safety of the securities compared to so-called periphery debt. France -- which was stripped of its AAA credit rating by Standard & Poor’s this year -- may continue to gain from being seen as a shield against the crisis sparked by the specter of Greece’s possible exit from the euro.

Falling Yields

“France is in much better shape than Spain or Italy,” said Patrick Armstrong, a managing partner at Armstrong Investment Managers in London, which oversees $353 million. “I would expect outperformance versus those two on any risk aversion around viability of the euro.”

At its bond sale last week, France sold benchmark five-year debt at a record-low yield of 1.72 percent. The average cost of medium and long-term debt sold this year was 2.23 percent, down from 2.80 percent in 2011 and 2.53 percent in 2010, when it was the lowest annual level since the creation of the euro, according to debt-management body Agence France Tresor.

The bid-to-cover ratio, or the demand for French debt relative to the amount sold, was 2.43 in the first five months this year, compared with 2.38 in 2011 and 2.14 in 2010 and 2.09 in 2009. France has raised 55 percent of the 178 billion euros ($227.4 billion) earmarked for 2012.

Better Returns

“Yields have come down for all highly rated countries this year,” Armstrong said. “Germany can only go so low, and that may be drawing investors to France.”

French debt has returned 3.7 percent this year, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. In the same period, German securities returned 2.8 percent, Spanish debt lost 2.6 percent and Italian securities brought in 9.4 percent.

Since April 20, French debt returned 2.5 percent compared with Germany’s 1.7 percent, according to the indexes. Investors lost 0.7 percent in that period on Spanish debt and 0.8 percent on Italian securities.

The French-Spanish spread touched 348 basis points today, its widest according to data compiled by Bloomberg. It was 287 points April 20. The gap between the 10-year French bond yield and that of Italian debt is 293 basis points, up from 257 points on April 20.

Hollande Efforts

Concern that Spain, with its revised deficit of 8.9 percent of gross domestic product last year, will need to fund bank bailouts has driven its borrowing costs close to the levels that forced Greece, Ireland and Portugal to seek bailouts.

Spanish and Italian government debt is rated BBB+ by S&P. France’s rating was cut one level to AA+ by S&P on Jan. 13.

French returns have been boosted after Hollande reiterated his commitment to cutting the budget deficit and his willingness to work with German Chancellor Angela Merkel even as they differ on ways to resolve the region’s crisis.

“He has gained temporary credit,” said Alessandro Giansanti, a senior rates strategist at ING Groep NV in Amsterdam. “It’s partly a positive effect from the eagerness of Merkel and Hollande to enter into constructive talks.”

Giansanti sees French-German spreads narrowing to about 100 basis points in the short term and to be in a 130-170 basis-points range in the medium term.

That’s even though Merkel and Hollande may be heading toward confrontation over joint euro-area borrowing at a meeting of European Union leaders in Brussels today.

Euro Bonds

The French president has said “everything will be on the table” including euro bonds. Merkel opposes selling common bonds, and a German official said yesterday that proposals for joint euro-area debt issuance probably won’t be discussed at the meeting.

Hollande has also said France will not ratify the Merkel-backed European fiscal treaty without a growth pact.

For all their differences, “the view is that Hollande will not try and rock the boat too much,” said Nick Eisinger, a sovereign analyst in London at Fidelity Investments, the second-largest U.S. mutual fund company with $1.2 trillion of assets.

“He is not going to materially upset Germany or the European Central Bank,” Eisinger said. “I think he will run a relatively sensible fiscal position and will concentrate on bringing the deficit down.”

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