Bloomberg News

French Debt Less Attractive as Reality Bites

June 26, 2012

French President Francois Hollande

Francois Hollande, France's president. Photographer: Andrew Harrer/Bloomberg

During his first two weeks in office, President Francois Hollande saw French borrowing costs go in one direction, and that was down. Not anymore.

The yield on the French benchmark 10-year bond advanced to 2.63 percent at 4:00 p.m. in Paris, up from a euro-era low of 2.071 percent on June 1. It was as high as 2.902 percent on May 15, when Hollande took office. The rate is at risk of rising further with French banks vulnerable to the region’s debt-ridden nations as economic growth stalls.

Investors already demand more than 6 percent to buy 10-year Spanish securities and almost as much for similar Italian debt. While Hollande has sought to reassure investors in France’s 1.35 trillion-euro ($1.7 trillion) sovereign debt market by repeatedly pledging to cut France’s budget deficit, the financial turmoil to the south makes his task more difficult.

“France has been out of the spotlight, but once the sheer misery of Spain and Italy is figured in, the next target will be France,” said Bill Blain, a Newedge Group Ltd. strategist in London. “I’m seeing a very small number of international institutional players buying French debt. People are very nervous.”

French government bonds handed investors a loss of 1.7 percent this month as of June 22, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. That compares with a first-quarter return of 2.4 percent and an advance of 3.9 percent in May.

Widening Spread

The premium investors demand to hold French 10-year debt rather than comparable German securities was 109 basis points today, after dropping below 100 on June 22.

Hollande’s pledge to shrink the budget gap had put France, which was stripped of its AAA rating by Standard & Poor’s in January, closer to Europe’s creditworthy north than to the struggling south. Yet with no sign of an enduring resolution to the region’s crisis, attention is turning back to French risks.

French banks, including BNP Paribas SA (BNP), Societe Generale SA and Credit Agricole SA, held $541 billion of private and public debt in Greece, Ireland, Italy, Portugal and Spain at the end of 2011, the most by foreign lenders, Bank for International Settlements figures show.

Also, France had zero growth in the first quarter, and joblessness is rising, making deficit-cutting goals harder to achieve. That may hurt holders of the country’s bonds, notably the long-term notes known as OATs.

Economic Slowdown

“If deficit numbers and/or GDP and unemployment in France are ugly in the next few months, nothing will save the OATs,” said Nicola Marinelli, who oversees $163 million at Glendevon King Asset Management in London.

Growth is suffering in France as companies see order books shrink and confidence wane. The Bank of France’s index for sentiment among factory executives has stagnated all year, suggesting gross domestic product may contract this quarter for the first time since Europe’s second-largest economy exited recession in 2009.

As Hollande turns his attention to tackling the deficit after months of campaigning -- first for the presidency and then for legislative elections that gave his Socialist Party control of the National Assembly on June 17 -- investors are seeing just how difficult his task will be.

Prime Minister Jean-Marc Ayrault called ministers in yesterday for a “budget seminar,” setting out the strictures for reducing the deficit to 4.5 percent of GDP this year and to 3 percent next year from 5.2 percent last year.

‘Government’s Headache’

For 2012, that means finding between 7 billion and 10 billion euros of savings.

Le Parisien daily flagged the meeting with the front-page headline “The government’s headache,” though Hollande and his ministers refuse to call what they’re seeking “austerity.”

“There’ll be tax increases, there’ll be spending cuts, but I reject any talk of austerity,” Finance Minister Pierre Moscovici said yesterday on I-tele. On France Info radio today he said, “We don’t want austerity; it’s what touches the middle class, hurts spending.”

The lack of growth makes the government’s deficit targets harder to reach by diminishing tax receipts and driving up costs for unemployment benefits. Jobless claims rose to 2.89 million in April, the highest since September 1999.

The Labor Ministry probably will show another increase for May when it reports the figures later today, according to three economists surveyed by Bloomberg News.

Conflicting Views

Investors such as John Stopford of Investec Asset Management say they will buy French debt given how constrained Hollande will be in his options.

“We are comfortable with French paper, and we will buy into its weakness,” said Stopford, Investec’s head of fixed income in London. “We have some caution over what Hollande is doing, but his room to maneuver is limited.”

Then there’s Humayun Shahryar, chief executive officer of Auvest Capital Management Ltd. in Nicosia, Cyprus, with about $100 million under management.

“France is going to be a big domino in the euro zone,” he said. “At the moment markets are more focused on Spain and Italy, but that could change very fast. It could even be that the markets ignore Italy and go straight to France.”

To contact the reporters on this story: Mark Deen in Paris at markdeen@bloomberg.net

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


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