Europe’s Divisions Are Causing Problems in the Bond Market

  • French development agency pulled a bond sale this week
  • Government bonds sold off ahead of presidential elections

Political uncertainty in Europe is starting to cause problems for the region’s safest borrowers, even as investors demand riskier bonds.

France’s government-linked development agency postponed a $1 billion bond sale this week, citing market volatility, while a junk-rated shipping company managed to increase the size of its sale. Agence Francaise de Developpement received insufficient orders because of investor concern that the notes would suffer in line with French government bonds amid the country’s fragmented presidential election, according to head of treasury Bokar Cherif.

Some top-rated borrowers are vulnerable to price swings in sovereign debt because their fortunes are so closely linked to underlying rates. The threat of an anti-establishment president in France, along with elections from Germany to the Netherlands, potential deadlock in Italy and Britain’s negotiations to exit the European Union may damp investor demand for the highest-rated notes at the same time as the European Central Bank prepares to curtail its purchases.

“There’s a lot of known political risk in Europe this year,” said Roger Webb, a London-based investment director at Aberdeen Asset Management Plc, which manages about 303 billion pounds ($381 billion). “We shouldn’t be surprised if there are periods during the year when deals get pulled because the underlying government bond market is particularly volatile.”

Try Again

AFD, which holds the third-highest investment-grade rating and provides funding for sustainable projects in developing countries, may wait until after elections in April and May to resume the sale, Cherif said in a phone interview. It’s rated AA at S&P Global Ratings and Fitch Ratings.

The development agency didn’t pay fees to Barclays Bank Plc, BNP Paribas SA, Deutsche Bank AG or JPMorgan Chase & Co. for arranging the three-year dollar offering and may not use the same lenders when it tries again, Cherif said.

“The performance of our notes is completely pegged to the French sovereign,” Cherif said. “Investors are trying to get a grasp of the political situation in France. The only thing we can really do is acknowledge that there are worries and take them into account in our plans.”

The same day AFD pulled its deal, German shipping company Hapag-Lloyd AG increased the size of a bond add-on by 50 million euros to yield 6.186 percent, according to a person familiar with the matter. The company is rated B2, five levels below investment grade. Junk borrowers are benefiting from investor demand for high-yielding securities.

Stress Signal

“It’s quite surprising that a borrower that’s that high quality would feel the need to pull back,” said Gordon Shannon, a money manager at TwentyFour Asset Management in London, referring to AFD. “It’s a big signal to the stress that’s starting to build here.”

TwentyFour oversees about 7.6 billion pounds and is underweight European credit because of political instability.

French 10-year bonds widened to yield the highest premium versus German notes since 2012 this week as corruption allegations against the establishment candidate Francois Fillon threatened to shift voter support to anti-euro candidate Marine Le Pen. Election uncertainty is heightened after polls failed to predict outcomes of the Brexit vote in June and the U.S. election in November.

The cost of insuring French debt also surged this week, with credit-default swaps rising to a more-than two-year high of 52 basis points, compared with 22 basis points for Germany, data compiled by Bloomberg show. Traders bought and sold more than twice as much insurance last week as the previous week, according to the Depository Trust & Clearing Corp.

“Given the number of elections ahead of us and the Brexit negotiations, there are likely to be days and possibly weeks where there’s volatility in underlying rates,” said Sarwat Faruqui, co-head of the international debt syndicate at MUFG Securities in London. “Timing the market is likely to be more important than it was last year.”

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