French government bond ETFs in focus as Le Pen/Macron showdown looms

Feb 13th, 2017 | By | Category: Fixed Income

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French government bond ETFs have been granted a small reprieve after a burst of bond buying last week calmed down the 10-year yield, but longer-term uncertainty remains in the run-up to the French election.

Le Pen Macron French Government Bond ETFs

Marine Le Pen and Emmanuel Macron are the two favorites ahead of France’s Presidential election, the first round of which is scheduled for 23 April 2017.

The 10-year benchmark yield has eased back to around 1%, and the divergence over 10-year German Bund yields also pulled back from a four-year high. It was welcome news for investors after the yield had risen from 0.1% last August to a peak of 1.1% in early February 2017 – the iShares France Government Bond UCITS ETF (LON: IFRB) dropped more than 7% over that period in euro terms. The value of bond ETFs, which track the value of bond prices moves inversely with yields.

But investors are still nervous after failing to predict the two largest jolts to the system last year – Brexit and the US election of Donald Trump. Traders have also started to price in the increased risk of victory for Marine Le Pen and her Front National Party this April in the French election, even though polls predict she will come in second place.

Le Pen caused controversy when she announced her plan to pay back government debt in a new French franc currency as part of a quest for monetary sovereignty.

David Rachline, head of strategy for the National Front, said in an interview that only about a fifth of France’s total public debt “falls under international law [and would stay denominated in euros] . . . but for the rest we will have the right to change the currency.”

As a result, bond investors have been analyzing their contracts, fearing redenomination risk. Ratings agencies predict such an outcome could trigger the largest sovereign default on record.

And as Marine Le Pen appears to be knocking away contenders from the left, right and centre – President François Hollande, former Prime Minister François Fillion and current leading candidate Emmanuel Macron to name a few – the markets are still uncertain as to who could be next in the running, and, ultimately, who will win on 23 April.

“We’ve had so many twists and turns that it is [getting] to the point that French politics is taking over from [US President Donald] Trump and is not just driving the German-French spread but it is starting to drive absolute levels of yield with respect to [US] Treasuries and German Bunds as well,” Daniel Loughney, a portfolio manager at Alliance Bernstein, told Bloomberg in a video interview.

French equities have not been hit as hard as fixed income, however, as the UK’s decision to leave the EU did not immediately result in financial calamity as some predicted. The iShares MSCI France UCITS ETF (LON: IFRE) generated barely positive returns of 0.17% year to date but has returned 22.4% over 12 months in euro terms.

It is difficult to predict how investors will react to uncertainty. Some may look beyond politics to Europe’s broad economic recovery. For those investors, IFRB from iShares costs just 0.20% and physically invests in 45 bond issues with a weighted average maturity of 9.5 years. The fund’s performance is down 2.8% year to date in euro terms, and has slipped 3.5% over the same period in sterling terms (LON: SFRB).

Other investors might want to reduce exposure to France. For fixed income ETF investors, there are an array of passive funds that track sovereign debt from across Europe.

The iShares Core EUR Government Bond UCITS ETF (LON: IEGA), for exampleis much more diversified than single country exposure and one of the largest in terms of assets, but it has fallen 0.5% over one year in euro terms. It costs 0.20% and tracks 312 holdings with a weighted average bond maturity of just over nine years. Almost a quarter of the exposure is in France. Italy (23.8%), Germany (18.1%) and Spain (13.4%) make up the next three largest country exposures.

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