| PARIS, April 15
PARIS, April 15 France is borrowing at its
cheapest rates ever, but to keep costs so low it must satisfy
the European Union and investors that structural reforms are on
track and hope the euro zone crisis can be held under control.
A euro zone country missing its fiscal targets, on the brink
of recession, with an unpopular president and a population
notorious for its resistance to reform, might seem the perfect
combination to scare away investors.
But France benefits from being in many ways a halfway house
between other, more robust, core euro zone economies and
crisis-hit periphery states whose debt offers higher returns but
with more risk.
Its long-held position as one of the world's richest
economies, and place beside Germany at the heart of Europe, have
also helped its yields fall this year from already low levels as
cash from global central banks washes through markets.
"French bonds are in a sweet spot," said Franck Dixmier,
Allianz Global Investors' head of European bond investments.
"This decorrelation between French bond yields and France's
economic fundamentals could go on as long as investor sentiment
towards the country remains relatively positive.
"But France is walking a tightrope," he warned, pointing at
risks including a further flare-up of the debt crisis or the
loss of France's sole remaining triple-A credit rating.
A key test will be France's revised fiscal policy for the
next four years, which President Francois Hollande's cabinet
will adopt on Wednesday. It must be solid enough to convince
euro zone partners to give the country a one-year reprieve to
bring its deficit below the EU's 3 percent of GDP ceiling.
"I think Hollande will be able to create more goodwill in
Brussels if he pushes reforms on the structural front," said
Willem Verhagen, senior economist at ING investment management.
"Spreads (within the euro zone) have very little to do with
what we normally think of as fundamentals ... All is conditional
on a country being a 'good citizen'."
RESILIENT TO BAD NEWS
Poll ratings for Hollande's Socialist government are at
record lows after a string of bad economic releases. It has
acknowledged it will miss its deficit target this year and
slashed growth forecasts, while most analysts see a recession.
Unemployment is near 15-year highs just as it prepares a
sensitive pension reform and overhauls labour laws, and it must
find spending cuts of more than 60 billion euros by the end of
2017 to come anywhere near a promise to balance its budget.
To make things worse, the man in charge of organising the
belt-tightening, ex-Budget Minister Jerome Cahuzac, quit last
month after admitting he had a secret foreign bank account,
making the already unpopular reform drive look even shakier.
"In France, in some respects yields are immune to
fundamentals at the moment because there's abundance of
liquidity and there are expectations that there will be even
more of that," said Robert Talbut, chief investment officer at
Royal London Asset Management.
"It's very difficult to predict when this will change
because economic data doesn't seem to matter, political turmoil
(elsewhere in Europe) doesn't seem to matter, people just expect
more liquidity searching around for those yields in the future."
Dixmier at Allianz also noted the advantages of France's
deep and liquid bond market, which makes it easy to buy or sell,
and its appeal as a safe credit offering higher yields on its
bonds than the United States, Germany or Japan.
Since the beginning of the year, France has issued bonds at
an average rate of 1.42 percent, its debt management authority
says, nearly half a percentage point less than at end-2012 and
well below the previous record low of 2.53 percent in 2010.
Its benchmark 10-year bond currently trades at
record lows of just over 1.8 percent. That is nearly two full
percentage points lower than two years ago and far less than
10-year bonds of Spain and Italy, which both yield well over 4
percent despite sharp falls as the euro zone crisis has eased.
Talbut, who manages assets worth around 50 billion sterling,
said he was underweight on France because he thought yields
there were too low given the fundamentals.
Underscoring the resilience of France's bonds to bad
economic news, it sold 10-year paper at a record low yield of
1.94 percent in early April. On the same day, Markit's
much-watched purchasing managers' index showed the country's
dominant service sector shrank at its fastest rate in four
years, dragging down the reading for the whole euro zone.
Low yields have helped make servicing the debt of the zone's
second largest economy less onerous despite its economic woes
and the loss of two of its three top-grade ratings. Last year,
France cut its interest bill by 0.7 percent even as its debt
grew from 85.8 percent of GDP in 2011 to 90.2 percent, to reach
over 1,833 billion euros.
Investors have kept buying French debt despite its missing
its budget targets for years, but some warn the bleak growth
outlook in France and its euro zone trading partners will
eventually catch up with the country and push up its yields.
"The risk of a recession in France and the Netherlands
and the weak growth in Germany have not yet been entirely priced
in by the market," said Morgan Stanley's Elaine Lin, who argues
that the markets were on the brink of reassessing French debt
before Japan's policy shift caught them off guard.
The Bank of Japan announced unprecedented stimulus plans
earlier this month, while other global central banks also
continue to print money to help foster economic growth.
Even before that, buyers in Asia and the Middle East were
responsible for half of net purchases of French government bonds
in 2012, with total non-resident holders of French debt reaching
On the other hand, Lin said, if the outlook in the euro zone
worsens it might encourage the European Central Bank to cut
rates, which could again drag German yields lower and make
French debt look more attractive.
The weight of central bank cash should anyway mean any
rebound in French yields is gradual, said Rachid Medjaoui, a
senior official at France's La Banque Postale Asset Management.
"In many countries, central banks want to keep real interest
rates negative," he said, pointing to liquidity injections by
major central banks including Japan and the United States.
(Additional reporting by Raoul Sachs and Marius Zaharia;
Writing by Ingrid Melander; Editing by Catherine Evans)