Bloomberg News

Sarkozy Trade Helps French Bonds Beat Bunds, Gilts: Euro Credit

February 07, 2012

Feb. 7 (Bloomberg) -- French bonds are delivering better returns than Europe’s AAA rated debt and U.S. Treasuries this year, thanks to what some investors call the “Sarkozy trade.”

Investors have made 1.4 percent, including reinvested interest, owning government bonds sold by France, which lost the top credit rating from Standard & Poor’s last month. They made 0.2 percent on Treasuries and lost 0.5 percent on German bunds, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies.

The European Central Bank’s unprecedented 489 billion euros ($638 billion) in three-year loans has flooded banks with funds, which in turn have been recycled into sovereign bonds, as French President Nicolas Sarkozy advocated on Dec. 9. As a result, investors have made more money on French and so-called euro-area periphery bonds than on bunds, U.K. gilts and Treasuries, which delivered some of last year’s biggest returns.

“The freer funding has been a game changer,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London. “It was dubbed the Sarkozy trade. What it does is offer breathing space, particularly for Spain and Italy. What helps Italy inevitably benefits France.”

France’s benchmark 10-year bonds yield 2.87 percent, down 32 basis points since Dec. 7, the day before the ECB unveiled its loan plan. Italian and Spanish 10-year bond yields have fallen 34 basis points and 43 basis points respectively.

Sarkozy’s Role

For much of last year, Sarkozy’s government pressed for a bigger role for the ECB in the crisis-fighting effort, an idea opposed by Germany. After months of wrangling, Sarkozy and German Chancellor Angela Merkel agreed on Nov. 24 to stop debating the central bank’s fire-fighting role.

Two weeks later, the ECB said it would offer unlimited cash to banks at 1 percent for three years and ease its collateral rules. The lending to banks allowed ECB President Mario Draghi to sidestep objections from Germany, Europe’s largest economy, to so-called quantitative easing along the lines of that used by the U.S. Federal Reserve and the Bank of England to help support their national bond markets.

After the ECB announcement, Sarkozy said governments in Italy and Spain could call on their countries’ banks to buy their bonds. “Each state can turn to its banks, which will have liquidity at their disposal,” he said at a summit in Brussels.

The ECB, whose first long term refinancing operation, or LTRO, was on Dec. 21, will offer a second such loan on Feb. 28 as the region seeks an end to the crisis, now in its third year.

Win-Win

“This is a huge amount of liquidity injected into the system,” said Thomas Costerg, an economist at Standard Chartered in London. Whatever happens at the second loan “will be a win-win. If take-up is big, it will be a good sign because people will translate it as backdoor quantitative easing. If it’s small, the interpretation will be that nobody needs it.”

For France, the ECB action was enough to help it ride out the turbulence created when S&P stripped it of its AAA credit rating for the first time.

The Jan. 13 downgrade was followed six days later by the sale of 7.97 billion euros of debt at lower borrowing costs. Yields fell again on Feb. 2 when France sold another 7.96 billion euros of bonds.

“The first thing we did when France was downgraded was increase our position in five-year paper,” said Gareth Fielding, chief investment strategist at Quantum Global Wealth Management, based in Zug, Switzerland. “French bonds offer significantly more yield than Germany. No chance of a default. Even if you only look at the two year, why would you hold Germany at 0.2% when France will return 0.5%?”

Italian Exposure

The risk-adjusted return, after volatility is taken into account, from French securities was 0.4 percent as of the end of last week, compared with 0.1 percent each for Treasuries and bunds and a 0.1 percent loss on gilts.

Risk-adjusted returns are calculated by dividing total return by daily price swings.

For strategist Spiro, the ECB loans were of direct help to Italy, which in turn helped France by easing concern about its banks’ exposure to its southeastern neighbor. French banks have the largest debt holdings in the five crisis-hit countries, at $620 billion as of September, much of it in Italy, according to data from the Bank for International Settlements in Basel.

“Italy is the focal point for investor anxiety,” Spiro said. It was “the Rubicon that had never been crossed, once it was crossed, the crisis became very much a crisis of the core, as well as the broad periphery. The LTRO helps France partly because it helps Italy.”

French Efforts

The ECB action alone isn’t capable of fixing Europe’s imbalances, nor is it solely responsible for the improvement in the outlook. The Citigroup Economic Surprise Index for the euro region rose to 16.6 last week, showing data are beating projections. It was as low as minus 21 last month when economic reports lagged forecasts.

Sarkozy’s government announced about 30 billion euros of tax increases and spending cuts in two packages unveiled last year to shrink the budget deficit. France’s budget gap narrowed to about 5.4 percent last year from 7.1 percent in 2010.

For Sarkozy, the turnaround may not come soon enough to keep him in office for another five years. With balloting beginning in 76 days, he trails Socialist rival Francois Hollande by six points for the first round vote on April 22 and by 22 points for the second and decisive round on May 6, according to an Ifop poll published Feb. 2.

“It’s not just the ECB,” Padhraic Garvey, head of developed markets debt at ING Bank NV in Amsterdam. “You have to stand back and accept that politicians, including those in France, have also done a lot. What they achieved may not be perfect, but they are pushing ahead.”

--Editors: Vidya Root, Mark Gilbert

To contact the reporter on this story: Mark Deen in Paris at markdeen@bloomberg.net Anchalee Worrachate in London at aworrachate@bloomberg.net

To contact the editor responsible for this story: Vidya Root at vroot@bloomberg.net


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