Marmite Baguette

ECB's French Folly

ECB, your medicine's worsening the disease.

Do you prefer Marmite debt over La Belle France?

Unilever NV, with its A1/A+ credit rating, managed a yield of just 1.03 percent for the 600 million-euro ($641 million) 10-year bond it issued Wednesday. France's Aa2/AA rating doesn't seem to be doing it much good, since its 10-year yielded a few basis points more at the time. 

Unilever is at least cash flow positive whereas France does have an ever-expanding deficit, but is the market really saying that Unilever has greater placement control of toiletries than a major European sovereign has in raising taxes? This does not seem to be an efficient measure of credit risk. There are two effects at play here, both the richness of corporates and the recent cheapening of France. 

Keeping a Lid on Corporate Spreads

ECB company bond purchases are shrinking the difference between corporate and government yields

Source: Bloomberg

Such a distortion can be placed at the feet of the European Central Bank and the impact negative rates and quantitative easing are having on trapping short-end yields so low. So the longer end has to take the strain, steepening the government yield curve. While some of the pickup in French yields might also be due to the upcoming tapering of the Public Sector Purchasing Program, it is also down to the recent repricing wider of France versus Germany as euro crisis fears resurface.

While government bond yields have backed out, corporate spreads have held in amazingly. As yields on company debt fall, that must at some point restrict investor demand for longer-dated new issuance, which would be contrary to the program's aims of loosening funding availability. Continuance of the ECB's Corporate Sector Purchase Program might only make this worse.

Seven Year Itch

The power of the ECB's easing measures wane toward the long end of the curve, with the illogical result that sovereign debt yields more than a proxy for bank credit

Source: Bloomberg

Blank spaces indicate lack of issuance at that maturity

Longer-dated French government bonds are currently quoted wider than swap rates, an anomaly not seen since 2014. It is unusual to see the proxy for European bank credit yield less than one of the bedrock sovereign countries of the EU.  Recent political turmoil ahead of the presidential election is the driver here -- in the last four months, the gap blew out 40 basis points. This is a clear expression that the market is pricing back in euro breakup risk. 

And it is a French effect -- as the relationship between German government bunds and swaps is actually going the other way. 

Back to the Crisis

Recent slump shows investors see the French sovereign as riskier than European banks

Source: Bloomberg

A negative number indicates government yields are higher than swap rates

The ECB must be aware of the distorting effect QE is having both on government and corporate bonds. It is about time they took steps to correct these effects, which has at its root the insistence on continuing QE for countries that don't need it -- something the Bundesbank reminds them of incessantly. QE should be focused on countries that still need it, and purchasing for the rest should just fade away.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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    Marcus Ashworth in London at

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