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Hollande Deficit Vow Lures Investors to French Debt: Euro Credit

French President Francois Hollande
Francois Hollande, France's president. Photographer: Michele Tantussi/Bloomberg

French voters head to the polls this weekend with at least one material benefit from President Francois Hollande’s three-week-old reign: record low borrowing costs.

The yield on France’s benchmark 10-year bond slid last week to an all-time low of 2.07 percent. The spread with equivalent German securities has narrowed to 110 basis points from 142 when Hollande took office on May 15. The government took advantage of the drop by selling today 7.84 billion euros ($9.9 billion) in debt, including 50-year bonds for the first time since 2010.

Hollande has stuck to his pledge to shrink France’s budget gap while gaining from predecessor Nicolas Sarkozy’s record of repeatedly beating the nation’s deficit-cutting targets. For bond investors, the combination has put France -- which was stripped of its AAA rating by Standard & Poor’s in January -- in the league of Europe’s creditworthy north rather than its struggling south.

“What we’ve seen is investors becoming more comfortable with French risks,” said Harvinder Sian, a senior fixed-income strategist at Royal Bank of Scotland Group Plc in London. “We are happy not to short France anymore.”

French voters choose lawmakers for the National Assembly in two rounds of voting on June 10 and June 17. Hollande’s Socialist Party probably will win the largest bloc of seats, although it may have to rely on other parties for a majority, according to an OpinionWay poll taken June 4 and June 5.

Fiscal Austerity

“An absolute majority of Socialists would increase the probability that the government will be able to deliver tougher fiscal austerity,” said Dominique Barbet, an economist at BNP Paribas SA in Paris.

While the European Commission said May 30 that France may need to take “significant” steps to meet its target of reducing its budget deficit to 3 percent of gross domestic product next year, Hollande has reiterated that he expects to meet that goal and plans to introduce fresh budget measures after the parliamentary elections.

His Finance Minister Pierre Moscovici said yesterday that “it’s a promise that will be kept.”

French bonds, Europe’s second-best performers in May after Dutch debt according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies, may extend the rally as investors seek shelter from the region’s crisis.

Spanish Yields

“The outperformance of French bonds reflects demand for high-quality paper with some yield,” said Ciaran O’Hagan, head of European fixed-income strategy at Societe Generale SA in Paris. “This demand should continue in coming months as long as concern about Spain lingers.”

The drop in French yields contrasts with increases in Spain and Italy. Spain now pays 6.15 percent to borrow for 10 years, up from the year’s low of 4.85 percent on Feb. 1. The equivalent Italian debt now yields 5.6 percent, compared with a 2012 low of 4.806 percent on March 8.

Spain, which has resisted pressure to become the fourth euro-area nation to seek a bailout, this week called for outside support for the first time as Budget Minister Cristobal Montoro said European institutions should help to shore up its banks.

Spain today sold 2.07 billion euros in debt, meeting its maximum target, as its 10-year borrowing costs rose to 6.044 percent, up from 5.743 percent at the last sale on April 19.

The spread between Spanish and German 10-year bond yields widened to a record 5.48 percentage points on June 1 and the cost of insuring against default on Spanish sovereign debt rose to a historic high.

Perfect Fit

At the same time, French sovereign debt offers better returns than Germany, where 10-year bonds provide a yield of just 1.25 percent and two-year yields went negative for the first time on June 1.

“We may be entering a tipping point where investors are forced to chase returns somewhere and are looking outside of Germany,” said Michael Gayed, chief strategist at Pension Partners LLC in New York. “There’s a crowding out effect. You look around the euro zone countries and France makes sense.”

In November, the premium investors demanded to hold French 10-year bonds rather than comparable German debt rose to 200 basis points, the most since 1990. That spread has almost halved as investors face fewer options that are safe and offer yield.

“With negative yields on German debt, demand was certain to propagate itself out to the next best credit which is liquid,” said O’Hagan. “France fits the bill.”

Manageable Risks

Today’s French bond auction had a bid-to-cover ratio of 2.1, suggesting investor demand remains strong. The sale included 3.84 billion euros in benchmark 10-year bonds at an average yield of 2.46 percent, the lowest since 1999. The treasury also sold 685 million euros in 50-year bonds at a yield of 3.27 percent.

“There are still challenges ahead for France and I’m watching the elections to have a clear idea of the true momentum of reform, but compared with Spain, France’s risks appear sufficiently priced in and manageable,” said Robin Marshall, director of fixed income at Smith & Williamson Investment Management in London, which manages about $18 billion.

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