Waiting for GodOAT
Markets are treating France a bit more like Italy, and that is unusual enough to demand an explanation. In August, the yield on the Italian 30-year BTP was, on average, 0.01 percentage points below the equivalent maturity French OAT. Let’s not pretend this elevates Italian BTPs to the status of a safe asset — Italy’s debt burden is still heavier than France’s. But it does suggest investors are reassessing French political risk (a budget due in October; a presidential election next spring).
France’s fiscal position is hardly a new problem. It has had dicey public finances almost every year since the birth of the euro. It has overshot the currency union’s deficit rule more than 20 times, and its debt-to-GDP ratio has been consistently above the limit since 2003. It has paid for this in higher borrowing costs, and repeated EU corrective procedures, but not yet in an actual debt crisis.
French yields today are similar to where they were during the euro sovereign debt crisis in 2009-2012. But so are almost everyone else’s. The bigger problem is the move in spreads — the difference between the yield on two bonds. The 10-year French OAT yield is about 0.87 percentage points above German Bunds, which is about 0.4 percentage points above the average since Mario Draghi’s declaration to do “whatever it takes” to save the euro in 2012. To put it in even more nerdy terms, that’s in the 99.8th percentile of spreads since Draghi’s speech — meaning it’s rarely been wider.
Of course, many have forecast a French debt crisis before. The closest the country has come to a debt reckoning in the 21st century was around 2011, when the spread to Germany hit 1.89 percentage points. France got through that. But that may have had less to do with the country fixing its finances than with being a kind of middle child whose problems were neglected while the parents (read: bond markets) were busy with the younger siblings.
But the big difference between then and now is the implicit backing of the European Central Bank. Draghi’s pledge made clear that monetary union — whatever its economic defects — was a political project European leaders were committed to preserving. The option to conduct outright monetary transactions — bond purchases — made that pledge credible (on top of prior targeted purchases under the securities markets programme). The more recent transmission protection instrument expanded the toolkit further, giving the ECB something closer to a financial stability tool, even if in the guise of monetary policy.
Neither OMT nor TPI has ever been used, and France would be an awkward test case. OMT was designed for countries under debt restructuring conditions. TPI sheds some of that conditionality, but deploying it for political risk in a core Eurozone country would be extremely controversial. If French spreads keep widening, we might see how usable it really is.
This doesn’t mean France is safe. One source of vulnerability is its investor base. As we showed in a recent chart (reminder to sign up here), more than 60 per cent of French debt is held by foreign investors, compared with about a third of Italian debt. Those investors are likely to be more flighty. Larissa de Barros Fritz at ABN Amro estimates that about 35 per cent of OAT holders are price sensitive, meaning pressure on OATs does not require a large sell-off: “A smaller reduction in demand from marginal buyers could already put upward pressure on yields.”
In Samuel Beckett’s play Waiting for Godot, originally written in French, two men wait for a man named Godot who never arrives. France’s debt crisis has acquired a similar quality. Investors have waited for years for France’s fiscal position to collide with market discipline, only for the reckoning to be postponed by low rates and crises elsewhere. The ECB’s backstop makes its arrival much less likely than before, but it doesn’t require a full-blown debt crisis for French finances to become uncomfortable.