Investors demanded a higher premium to hold France’s debt instead of Germany on Wednesday, reflecting a combination of political uncertainty and concerns over the outlook for inflation and central bank debt purchases.
A series of upcoming elections in Europe, combined with worries that inflation pressures are picking up, have pushed down eurozone bond prices since the start of the year, with France becoming a notable laggard.
The benchmark 10-year French yield has climbed towards 1.10 per cent, more than 60 basis points above that of the equivalent maturity German Bund, a divergence not seen since January 2014. The risk premium between French and Belgian bonds, which carry similar credit ratings, has also reached a three-year high.
“We have seen in the recent days an acceleration in the underperformance of French bonds,” said Olivier de Larouzière, head of interest rates at French fund house Natixis Asset Management. “Volatility is clearly going to remain high during the two months to come before the election.”
François Fillon, the presidential candidate many assumed would easily beat far-right politician Marine Le Pen, has suffered a sharp decline in approval ratings following the accusations that he used state funds to pay his wife and children for fake jobs, which he denies.
The fallout has left French bonds trading at sharply higher yields, as investors reconsider the chances of the far right National Front party in upcoming elections in April and May. The National Front has campaigned on a nationalist programme and pledges to remove France from the eurozone if it wins.
Lyn Graham-Taylor at Rabobank said that the poor performance of Mr Fillon in opinion polls does not mean Ms Le Pen will clinch the presidency because of the mechanics of French elections, which are held in two rounds.
“We would then view this as offering an attractive entry point for long French positions as it remains extremely unlikely that Le Pen will triumph in the second round,” he said.
Debt market investors are also focusing on how long the cushion of European Central Bank bond buying will last as data released on Tuesday showed inflation in the euro zone hit 1.8 per cent in January.
Monthly purchases designed to hold down borrowing costs will be tapered from €80bn to €60bn in April, but the programme is intended to run until at least the end of 2017.
However bank strategists at Morgan Stanley among others have already started to plot how markets might react if the scheme is wound up earlier, as headline measures of inflation continue to pick up and move closer to the ECB’s target of just below 2 per cent.
The recent underperformance of French bonds has not prevented the country from issuing debt, including its first “green” bond designed to fund environmental projects, and Mr de Larouzière pointed out that bond issuance this year was likely contributing to the moves in bond yields.
France has sold a large number of long-dated bonds since the start of the year, including a 50-year bond. Large sales can lead to a fall in prices elsewhere as investors make room for the new issues and sales are due to remain high until April. Investors might wait until then before considering large investments in French bonds, he said.
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