Hollande Risks Squandering French Bonds’ Sweet Spot
French 10-year bond yields have barely budged since Moody’s Investors Service Inc. on Nov. 19 followed Standard & Poor’s January decision to strip France of its top rating, rising about 10 basis points to 2.18 percent. Borrowing costs have declined since Hollande’s May election, prompting him to boast last week that 10-year yields near their Aug. 3 record low of 2.002 percent validate his policies.
Far from it, say strategists such as Michael Quach at Smith & Williamson Investment Management in London, who sees French bonds benefiting from European Central Bank actions and pledges. Also, being higher rated than Italy and offering better returns than German debt, France is in a bond market sweet spot that belies its woes of almost no growth, unemployment at a 13-year high and an Hollande revival plan that Moody’s calls inadequate.
“Moody’s doesn’t necessarily provide new information about France but its move did put a spotlight on the country,” Quach said. “French yields are historically low because of the global backdrop and what the ECB has done. France should use this opportunity to get reform through because we don’t know how long the market will be in this condition and when investors will lose their patience.”
Investors are demanding 73 basis points more to hold French 10-year bonds than comparable German bunds, down from 200 points a year ago and 143 basis points when Hollande took office.
The yield on 10-year French bonds was little changed at 2.17 percent at 11:50 a.m. London time. Two-year notes yielded 0.14 percent.
Moody’s downgraded French sovereign debt by one level to Aa1 and maintained its negative outlook, citing what it said was a worsening growth outlook. S&P lowered the rating by one level to AA+ from AAA on Jan. 13.
Still, French bonds have handed investors an 8.8 percent return since the S&P downgrade, more than double the 3.9 percent gain from AAA rated sovereign bonds, according to Bank of America Merrill Lynch indexes. Top-ranked German bonds returned 3.1 percent.
The gains underscore how downgrades by credit-ratings companies are being shrugged off by investors. The U.S. has been deemed more creditworthy by investors since S&P removed the nation’s AAA grade in 2011, with 10-year note yields dropping to a record this year.
A shrinking supply of AAA rated assets globally -- the number of issues in a BoA Merrill Lynch AAA index fell to 3,601 from 5,223 in 2007 -- is aiding French bonds, said Adrian Owens, a money manager in London at GAM, which has $48 billion in assets under management.
“Because of the increasing scarcity of AAA rated assets, investors are forced to move further along their risk curve,” he said.
Still, the downgrade of Europe’s second-biggest economy underscored the concern expressed by allies of German Chancellor Angela Merkel that the Socialist Hollande’s failure to recognize the urgency of France’s woes risks deepening Europe’s slump.
It “would be good if the Socialists there would courageously initiate real structural reforms now,” said Volker Kauder, head of the parliamentary group of Merkel’s Christian Union bloc, according to a Spiegel magazine report this month.
German Finance Minister Wolfgang Schaeuble was compelled to come to France’s defense last week when he spoke out against his countrymen calling France the “sick man” of Europe.
“France’s economy is in more of a chronic than acute state, unlike what we see in Ireland or Spain, for example,” said Bill O’Neill, chief investment officer for Europe, Middle East and Africa at Merrill Lynch Wealth Management, which oversees about $1.8 trillion globally. At a London presentation yesterday he said Merrill isn’t buying French government debt.
“France is going to be every bit as big a debacle as Spain,” John Mauldin, president of Millennium Wave Advisors, said on Bloomberg Television’s ”Money Move” today. “They have too much debt and they are not dealing with it.”
“Moody’s sanctioned the delays France has taken to deal with its debt and its loss of competitiveness,” he told reporters in Paris on Nov. 20. “We see it as an invitation to pursue the reforms that we’ve undertaken. France must cut its deficit and restructure to make its economy more competitive.”
The International Monetary Fund and European Commission expect France’s economy to expand 0.1 percent and 0.2 percent respectively in 2012. They see growth of 0.4 percent next year, half Moscovici’s forecast.
The discrepancy will make the Hollande government’s promise to slash the deficit to 3 percent of gross domestic product next year harder to keep -- one of the reasons cited by Moody’s for its rating cut -- and probably means that unemployment will climb higher from its current 10.2 percent.
“There’s a glaring disconnect between France’s deteriorating fundamentals and the country’s record-low bond yields,” said Nicholas Spiro of Spiro Sovereign Strategy in London. “France remains one of the biggest anomalies in the European sovereign credit landscape. Yet the French bond market’s resilience is likely to persist.”
Key to that resilience is the implicit support of the ECB in the face of greater economic troubles in neighboring Italy and Spain, where 10-year bond yields are 4.83 percent and 5.68 percent respectively, compared with 2.14 percent in France.
The ECB has ploughed 1 trillion euros ($1.3 trillion) of liquidity into the region’s financial system and ECB President Mario Draghi agreed in September to buy the bonds, under some conditions, of euro nations whose yields have skyrocketed.
With debt at about 126.5 percent of gross domestic product, Italy’s burden is more than a third bigger than France’s. Meanwhile, Spain’s budget deficit this year will be 8 percent of GDP compared with France’s 4.5 percent, according to Eurostat.
“France has poor and deteriorating fundamentals but their bonds are doing well because of demand from investors who seek relatively safe bonds with higher yield pickup and investors who give policy makers the benefit of the doubt,” said GAM’s Owens.
Hollande is starting to take steps to tackle France’s record trade deficit and high labor costs, saying this month that he’ll raise sales taxes to pay for a cut in charges on business. At a 2 1/2 hour press conference on Nov. 13, the Socialist president also pledged 60 billion euros in spending cuts over five years.
Hollande has asked unions and business leaders to agree on ways to increase labor flexibility by the end of the year, threatening to decree change if there is no accord.
“Paris shouldn’t wait until the conclusion of the current negotiations between unions and the employers’ federation to start fleshing out precisely its definition of a more flexible labor market in France,” said Gilles Moec, co-chief European economist at Deutsche Bank in London. “The market for the time being is giving France the benefit of the doubt, but a further clarification of the policy stance is becoming urgent.”
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