Things that happened in 1992:
- Bill Clinton was elected US President
- Queen Elizabeth II had an annus horribilis
- The Maastricht Treaty creating the modern EU was signed
- Britain and Italy crashed out of ERM (the former forever)
And it is fair to say that in those troubled ERM days, the French franc and the French government’s bonds were subjected to a high degree of market pressure versus the Deutsche Mark and Bunds. This included sharp one-day moves in the spread to Bunds and an overall high level for this spread.
Nineteen years later… we’re back Back in terms of spread difference and volatility, the points we made above, that is. As pointed out in comments, actual French bond yields remain extremely low for the purposes of managing debt.
Chart via Reuters. As ever, theories on why it’s happening now are welcome.
In general though, maybe it is apt to recall ERM. The ERM design of course took damage from markets probing each government’s commitment to the mechanism in turn in 1992. It’s a bit like how the EFSF today is a big sovereign correlation machine. Proposals for it to insure weaker sovereign bonds in the structure, make it all the more so.
Updated (1710 UK time) — A bit more on the parallel shift in EFSF credit, which is where many explanations for the sudden French rout are starting. In the first place, Stefano Di Domizio of Lombard Street Research has been arguing for a while that French bonds are simply vulnerable to a ‘dilution’ effect from the EFSF issuing more debt in the near future. It’s an argument which seems to be paying off.
There’s more on this theme from Divyang Shah of IFR Markets on Tuesday,
However, just as worrying is the rising cost for the EFSF which has seen its 5yr bonds 2.75% 07/16 widen out to 46.5bps vs mid-swaps compared to a level of around 41bps on Monday [it's reached 50bps at pixel time - Ed]. The slow widening on EFSF bonds is not a new phenomenon and accelerated in mid-Sept when talk of leveraging the EFSF first surfaced and has since gained much more traction. Clearly the market is worried about having to digest a lot of supply (related to Italy and Spain issuance as well as a Greek bailout) compared to the current bailout commitments related to Portugal and Ireland.
The guarantee nature of the AAA EFSF should make it different to the sovereign bonds of AAA France for investors. However, what we have seen is that since the first EFSF bond was issued 1) they have underperformed Germany with the 5-year spread widening from trading below 50bps vs 5-year Germany to trading currently around 121bps over Germany 2) while during the same period the EFSF spread to 5-year France has gone back to within its previous range between 20/25bps.
Indeed one can argue that what we are seeing on French bonds currently is simply a catch-up play to what we have seen on EFSF bonds since mid-Sept. Given the perception that AAA France could be a weak spot to the AAA EFSF the price action of EFSF bonds with regards to Germany and France is understandable.
On the other hand, France has under-performed German debt so quickly that you have to wonder how much worse it can get in the shorter term. (Although those may be famous last words.)
Related link:
Your deterrent is my bluff – FT Alphaville