In Europe: France AAA Rating in tatters as yields surge

22 November 2011

The tribe has spoken…S&P’s rating ‘error’ seems to have sunk into the subconscious of investors.

Investors aren’t waiting for Standard & Poor’s or Moody’s Investors Service to strip France, Europe’s second-biggest economy, of its top credit rating.

The extra yield demanded to lend to AAA rated France for 10 years was 158 basis points more than the German rate at 11:51 a.m. today. The gap was 200 basis points on Nov. 17, the widest spread since 1990, up from 28 in April. The French 10-year yield was at 3.5 percent, about midway between top-rated Holland and Belgium, which is graded one level lower at Aa1 by Moody’s. French borrowing costs are more than a percentage point above the AAA rated U.K.

“France isn’t trading like a AAA,” said Bill Blain, a strategist at Newedge Group in London, who recommends buying U.K. government debt. “The market has made its judgment already.”

The debt crisis that began more than two years ago in Greece and snared Ireland, Portugal, Italy and Spain is close to reaching France. Moody’s said in a report published yesterday that any persistent increase in borrowing costs would amplify the French government’s challenges as economic growth slows.

President Nicolas Sarkozy has unveiled two sets of budget cuts since August to preserve the credit rating and try to calm jittery markets. Two-year yields on French debt have climbed 55 basis points since Aug. 31 to 1.67 percent, while the rate on German notes of similar maturity fell 30 points to 0.42 percent.

“The market is concerned about the dissolution of the euro itself, hence only bunds are acting as a safe haven,” said Richard McGuire, a fixed-income strategist at Rabo Bank International in London. Germany is the region’s largest nation.

Credit Suisse

French 10-year bond yields may climb above 5 percent, analysts at Credit Suisse Group AG said in a note to investors yesterday. Euro leaders must reach “a momentous deal” for fiscal and political union by mid-January to save the 17-nation bloc, Credit Suisse said in the report.

Yield spreads have widened for the other AAA rated euro- zone countries — Austria, Finland, the Netherlands and Luxembourg — bringing the crisis from the periphery to the so- called core.

France has the biggest debt burden of the top-rated euro nations, at 85 percent of gross domestic product. Its financial institutions also have the largest debt holdings in the five crisis-hit countries, at 681 billion euros ($921 billion) as of June, according to data from the Bank for International Settlements in Basel.

“France is not a AAA at all,” said Nicola Marinelli, who oversees $150 million at Glendevon King Asset Management in London. “French banks are very exposed to euro-zone periphery. If they were to mark to market these loans at current levels, there would be huge losses.”

Weak Metrics

Moody’s and S&P currently have a stable outlook on French credit, though both have signaled the nation’s rating is at risk. Moody’s said Oct. 17 that France’s debt metrics “are now among the weakest” in the AAA club. France might be downgraded in a stressed economic scenario, S&P said four days later.

The prospect of France taking on additional liabilities to support countries such as Greece and Italy is among the main threats to its rating, according to New York-based Moody’s.

S&P roiled global markets on Nov. 10 when it sent and then corrected an erroneous message to subscribers suggesting France had been downgraded.

France says to resolve the region’s crisis the European Central Bankneeds to be the lender of last resort, supporting Europe’s rescue fund. The French proposal, which would allow the ECB to fund purchases of troubled sovereign debt, has the support of leaders such as U.K. Prime Minister David Cameron.

German Opposition

Germany and the ECB oppose the plan.

“We don’t have any new bazooka to pull out of the bag,” Michael Meister, a senior lawmaker in German Chancellor Angela Merkel’s coalition, said in a telephone interview in Berlin today, reiterating opposition to the ECB plan.

The stalemate has added to market perception that France, the second-biggest backer of the European Financial Stability Facility after Germany, may get dragged further into a crisis that this month led to the ouster of Italian Prime Minister Silvio Berlusconi and Greece’s George Papandreou.

“Where are the guardians of the euro?” asked Eric Chaney, chief economist at Axa SA in Paris. “The EFSF, the ECB? The markets are going to continue to test them. Markets are increasingly betting on a breakup of the euro zone.”

European leaders agreed last month to boost the EFSF to 1 trillion euros to help contain the crisis. The fund owes its AAA rating to guarantees from the euro region’s six top-rated nations. The EFSF’s lending capacity would fall by 35 percent if France is downgraded, Mizuho Corporate Bank Ltd. analysts said.

French Vote

Sarkozy, 56, who faces a presidential election in April or May, and his government have vowed to do everything to defend France’s creditworthiness. They point to a reserve in the country’s 2012 budget to compensate for any economic slump, and this month unveiled 18.6 billion euros in tax increases and spending cuts to defend the rating. They’ve pledged to do more if necessary to reduce the deficit to 4.5 percent of GDP next year and 3 percent in 2013, from 5.7 percent this year.

“France has shown its seriousness on the budget, we’ve adapted,” Finance Minister Francois Baroin said today on France 2 radio. “We’re borrowing at the best rates in the past decade and we’re watching the situation closely.”

The current 3.5 percent yield on 10-year bonds compares with an average 3.9 percent during the past decade. The French treasury completed its funding requirement for 2011 when it sold 7 billion euros of medium-term debt and 1.1 billion euros of indexed bonds on Nov. 17.

‘Self Fulfilling’

France’s medium and long-term funding costs had an average yield of 2.8 percent in 2011, the second lowest since the euro was created, according to Agence France Tresor, the country’s debt-management body. It was 2.5 percent in 2010.

The market has “taken on its own dynamic, with its own forecasts that are partly self fulfilling and very far from the any fundamental analysis,” Philippe Mills, the head of AFT, told journalists last week in Frankfurt.

With the election coming up, “it is by no means certain that the government will be able to implement the proposed fiscal tightening,” said Jennifer McKeown, an economist at Capital Economics in London. “The clear downside of France’s exposure to the euro zone’s south is that a failure to address the problems of Italy and the peripheral economies will have disastrous consequences.”


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