Photographer: Christophe Morin/Bloomberg
French Bonds Are Expected to Be the Worst European Performers in 2018By
Yield increase likely to take place in second half of year
German bonds likely to be well supported by favorable outlook
French bonds may have made it through 2017 without the election shock many investors feared, but they face an altogether different challenge in 2018.
The country is set to see a glut of government debt supply, which could mean its bonds are among the worst performers in Europe in 2018. JPMorgan Chase & Co., Citigroup Inc. and Deutsche Bank AG are among those recommending to position for French bonds to underperform other European sovereigns next year.
“France stands out as having the biggest swing in 10-year equivalent net supply and this is driven by higher gross supply and lower reinvestments than elsewhere,” wrote Citigroup strategists Harvinder Sian and Aman Bansal in a note to clients. France is the bank’s “preferred short,” as it recommends selling 30-year notes against Germany with a spread target of 60 basis points.
Yields on French 10-year government bonds surged early in the year on the risk of an election win for far-right populist Marine Le Pen, before falling back. They now stand little changed from the start of 2017 at 0.69 percent, having returned 1.1 percent to investors this year. By comparison, German 10-year bond yields have risen about 17 basis points this year to 0.37 percent, giving investors a loss of of 1 percent.
German bunds will continue to face an “accommodative environment,” with reinvestments from the European Central Bank focusing on the country, according to Deutsche Bank strategists led by Jack Di-Lizia. Mizuho International Plc strategist Antoine Bouvet also sees the Netherlands benefiting, notching up its third straight year of negative net supply.
European bond supply is likely to turn positive next year, once redemptions and ECB purchases are taken into account, according to most banks. That’s largely because the ECB is set to halve its number of asset purchases to 30 billion euros ($35 billion) per month for nine months beginning in January, leaving more securities left for the rest of the market to buy. There is a growing consensus that supply dynamics could push yields higher.
The decline in asset purchases will “weigh on European government bonds,” wrote BNP Paribas SA strategists Agne Stengeryte and Eric Oynoyan, in a note to clients. There is “a strong argument for a short duration position in the euro zone.”
April looks to be a supportive month with redemptions and ECB buying trumping new supply by nearly 50 billion euros, so it could be later in the year that yields begin to meaningfully rise. Much will also depend on how inflation plays out and at what point the ECB begins to adjust its forward guidance and bring a halt to new purchases.
Next year, bond markets are going to be “a tale of two halves,” said Themos Fiotakis, a strategist at UBS Group AG. The second half is “the point where most of the convergence toward the fair value of higher yields will happen.”