La Grande Illusion

Is the credit differential between France and Germany really only 107bp at 10yrs and 67bp at 5yrs? At the 12 month way-point, French yields are at 0.005%, not far from German rates which are -0.005%. I was taught to believe that there is no such thing as a bad asset, just a wrong price. Where does that leave the French yield curve?

I have one particular chum in Paris, formerly one of the city’s leading government bond price makers, who throws his toys out of the pram every time I forget to remind what a parlous state French finances are in. He has a point.

Are French yields being held down by anything other than the firm belief – or is it blind hope – that France will remain part of the European core?

While we are all staring towards Brussels for overarching action, we forget to look at the details of the component economies. French Industrial Production for May reported yesterday at an eye-watering -1.9% MoM (forecast -1.0%) and -3.5% YoY (-1.6%). The manufacturing component was even more scary at -1.0% MoM (-0.3%) and -4.3% YoY (-2.3%). My chap has been warning me for months that the wheels are coming off French industry and that the country is in the same process of de-industrialisation which the United Kingdom went through during the Thatcher era with the sole difference that nobody is watching.

Staying on the eurozone TGV

So why is the French bond market so strong? The answer is, so he believes, in the psychology of the eurozone. Were it to come to a realignment of the members, the so called two-speed solution, or even to the de facto expulsion of the odd member here or there, the market is pricing France to be on the high speed train and not on the stopping one.

However, given the still quite liberal splashing out of money which President Hollande does not have and at best hopes to raise through taxation, things are not at all good. It was increasing fixed future spending commitments on the expectation of equally consistently higher future tax revenues which eventually brought down that now invisible Scotsman who had supposedly abolished the boom and bust cycle and saved the world and which left this country’s finances in their highly parlous state. The current government talks a lot about reining this in but has, truth be told, so far achieved next to nothing.

Hollande might be a consummate Europhile but he is an unreformed fiscal dreamer and although he might well be a much better European than was his predecessor, this is clearly not an age where ideology pays the bills. Employing 20,000 new teachers might be a grand idea but with the decline in output and the debt/gdp ratio at 85.5% (12/11 reading) – and undoubtedly still rising – the focus must be on trying to make what is left more competitive.

Investing in infrastructure in order to prime economic recovery is a grand old idea but, as Spain is finding, putting it in is one thing, maintaining it is another entirely.

My tame Parisian is experiencing this on a day to day basis as the suburban transport infrastructure which was the envy of the world ten years ago begins to creak and delays and cancellations on the commuter routes is, by all accounts, no better than it is in London.

Alas, and so to the point. Are French yields being held down by anything other than the firm belief – or is it blind hope – that France will remain part of the European core? Ideologically, it most certainly is.

Does it, however, cut the mustard fiscally? If the answer is “Non”, then French 10yr bonds are most probably 200bp too tight to Bunds. We saw the wobbles with the Bund/OAT spread widen to the 200bp area at the back end of last year and even this year we traded wides closer to 150bp. At 100bp, the spread looks to my Parisian to be more like the triumph of hope over experience than a realistic pricing of the French sovereign credit relative to the German one.

No doubt OATs benefit from being the next best things to Bunds which are available in any size – ever tried to buy proper sizes in Finnish? – and with Bund yields now only being visible with a microscope, they are not all that unattractive. If, however, doubts were to be raised about France, I would not want to be standing in the path of a rush to the door.

On the other hand, where else can I put my money and not end up paying for the privilege? All sub-3yr yields in Germany are now negative.

One wonders why there are still people trying to get jobs in this industry.