BlackRock Investment Institute (BII) has pointed out that the sharp selloff in French government bonds serves as a reminder that an intensifying battle for capital is subjecting borrowers to tougher scrutiny, particularly in an environment where high yields abound globally.
Although global bond markets are broadly under pressure, France has emerged as the weak link: the government is trying to push through a cost-cutting budget while simultaneously dealing with nationwide protests over the cost of living and school conditions.
Strategists led by Wei Li wrote in a report that "the French government bond selloff shows that, against the backdrop of a global interest rate reset, competition for capital is reshaping fixed income markets," and that it is "increasingly important to figure out what is driving yields higher and whether investors are being adequately compensated for the risks they are taking on."
The spread between French and German 10-year government bond yields — a closely watched risk gauge — broke through 150 basis points on Tuesday, touching that level for the first time since October 5. The spread recently peaked at 159 basis points, the widest since the region's sovereign debt crisis in 2011.
The strategists wrote that "France demonstrates how important it is to be selective about which bonds you pick," and that "the widening spread over German bunds shows investors are still demanding extra compensation for France's fiscal and political risks."
Public unrest intensifies as French bond risk premium rises
Strategists said the eurozone today is far better equipped to handle a crisis than it was 15 years ago. The European Central Bank has more powerful tools, and the banking sector is far more robust than it was back then. BII noted that while France's debt-to-GDP ratio has ballooned to nearly 120%, the corresponding figure for the entire eurozone has now returned to around 89%, the level seen in 2011.
They added, however, that ECB intervention is "not guaranteed" and that "further volatility and spillover effects could still materialize."
While indiscriminate selling could create opportunities in markets with sounder public finances, such as Spain, BII remains neutral on eurozone government bonds.
Opportunities outside Europe are also plentiful. According to BII data, more than 80% of bonds globally now yield above 4%, compared with just 6.3% five years ago.
Strategists are particularly bullish on US Treasuries — having just upgraded their rating on US government debt last week — as well as emerging market local-currency bonds, especially in Latin America. They also trimmed their underweight position in Japanese government bonds, believing that most of the expected yield adjustment has already played out.
Comments