Hedge funds bet France is more peripheral than core |
Date: Friday, August 31, 2012
Author: Laurence Fletcher, Reuters
Hedge funds are going against market consensus and betting that ultra-low
French government bond yields are unsustainable, believing a sluggish economy
and the new government's policies will eventually force up borrowing costs. Investors have generally given
France the benefit of the doubt this year, treating it as a core euro zone
economy despite its debt. Its bond yields have, as a result, generally tracked
Germany's rather than struggling Italy's or Spain's. But many macro funds now think the yields, which have collapsed this year,
cannot remain around the lowest levels seen for more than 20 years. France's
economy, after all, is teetering on the brink of recession. The funds, which are often at the leading edge when it comes to future market
moves, are also sceptical about the policies of French President Francois
Hollande, who was elected in May. These include raising taxes on the rich and cutting the pension age to 60 for
some workers, risking a reduction in tax revenues, increasing pressure on
France's welfare system and hitting its credit rating. "The market seems to be looking at France as a safe haven, yet we very much
believe that French yields should be converging towards Italian and Spanish
yields rather than to those pertaining to
Germany," said Pedro de Noronha, managing partner at London-based Noster
Capital. French two-year yields were down at 0.17 percent on Thursday from around 0.6
percent at the end of last year, and just 0.19 basis points above Germany.
Italian and Spanish yields are 3.04 and 3.64 percent, respectively. The French 10-year yield, meanwhile, has dropped to 2.14 percent, about 100
basis points below where they were at the end of last year. "We have high conviction that, at some point in the not-too-distant future,
French public finances will start to deteriorate markedly thanks to Mr.
Hollande's irresponsible socialist policies," de Noronha said. Managers have placed their bets in a range of ways. De Noronha is shorting
the bonds and has offset part of the risk with higher-yielding senior secured
corporate bonds. Shorting means betting on a lower price for a security in the
future. Others have bought credit default swaps CDS.L - which are designed to pay out
in the event of default - whilst buying German bonds, which they believe will
perform better. CDS prices would rise if France's debt prospects worsened. Others have simply been shorting both French and German bonds in the belief
both yields are too low. Firm positioning data is notoriously difficult to find for this kind of
thing, but some hint can be taken from bond lending, at least some of which will
as a result of shorting. The quantity of French bonds out on loan has risen to $52.2 billion from
$50.5 billion a month ago, according to data group Markit. HEADWINDS FOR HOLLANDE France's 2 trillion euro economy faces plenty of headwinds. It is likely to
slip into a shallow recession in the third quarter, its central bank said this
month, while government growth forecasts for 2013 look set to be revised
downward. Meanwhile, jobless numbers are at a 13-year high, with more job losses
expected in September. There is also the debt issue -- which after all is the basis for the
euro zone crisis. France's debt to gross domestic product is around 90.5 percent, which is far
higher than suffering Spain's 80.9 percent. As for annual overspending, France's deficit as a proportion of GDP is headed
to 4.5 percent this year. Italy's is 1.9 percent. By these standards, the French economy would appear more peripheral than
core. Nevertheless, yields have continually defied the pessimists, hurting hedge
funds who had already bet against them. "It didn't work particularly well. But some macro funds are (still) riding
that sort of trade," said Scott Gibb, partner at $1.3bn fund firm Cube Capital,
who believes yields were driven down by purchases by central banks and insurance
companies chasing small but positive real yields. "The French should be paying more to borrow given our expectation of economic
deterioration there... France has got a lot of issues to solve. With likely
slowing growth (under ongoing austerity) and potential recession, increased
spending and taxation could create a very tough environment."
Reproduction in whole or in part without permission is prohibited.