French bonds enjoy best run since Brexit vote

French government debt has capped its best run since the aftermath of Britain’s vote for Brexit, underlining the rapid shift in investor sentiment towards the country’s presidential election which now looms over financial markets.

The yield on the 10-year French bond dropped to its lowest in a month, as money managers and traders continued to take succour after centrist candidate Emmanuel Macron received the backing of potential rival François Bayrou.

It has helped staunch a sell-off in French debt that has been fanned by fears Marine Le Pen, the leader of the far-right National Front, could pull off the next populist surprise as voters go to the polls in April and then again in May for a run-off between the two final candidates. She has vowed to pull France from the euro.

The 10-year bond’s yield, which moves inversely to the price, this month hit 1.14 per cent, its highest level since autumn 2015. It was down 4 basis points at 0.87 per cent on Monday, outshining UK, German and US debt.

Investors’ anxiety over the outcome of the election deepened this month after centre-right candidate and favourite François Fillon was hit by an embezzlement probe. He received a fillip on Monday after he won a temporary reprieve in the inquiry.

“Taking a view on France in the current climate effectively means taking a view on (often erratic) headline risks and requires a higher degree of tolerance for volatility,” fixed-income strategists at Citigroup said. “However, in our base [case] of a Fillon [victory], we do see value being built — but we just wouldn’t buy the dip yet.”

Although polls suggest Ms Le Pen will lose the second round of the presidential election, fears that she will deliver a shock victory is reverberating beyond French asset prices. German debt, seen as a haven in European markets, has been sought by investors ahead of the political risk the French presidential election represents.

The yield on the two-year German Shatz came within touching distance of minus 1 per cent last week, as a focus on politics outweighed signs that the German and the wider eurozone economy were showing signs of improvement. It drifted a basis point higher to minus 0.95 per cent on Monday.

“Securities with high credit quality, low volatility and relatively higher liquidity, such as the German front-end, are the ideal investment when risk aversion rises,” bond analysts at Bank of America Merrill Lynch said.

The surge in demand for shorter-dated German bonds prompted Morgan Stanley analysts to cut their year-end forecast for the country’s sovereign bond yields.

The bank’s rates strategists now predict that the two-year Schatz yield will end this year at minus 0.7 per cent. Although that represents a 60 basis point cut to their forecast from the end of last year, the US investment bank argues that the overall bond market will be under pressure this year as the European Central Bank begins to scale back a bond-buying programme that has helped drive yields to record lows.