Bond managers raise alarm about France downgrade

Amid the reporting of Ireland’s potentially terminal bank bailout last week, another eurozone woe passed relatively unnoticed: bond managers think France may be the next state to be downgraded.

Christophe Akel, a co-manager of the GLG Global Corporate Bond fund, revealed GLG already considers a downgrade a possibility and has gone long German credit default swaps and short French credit default swaps in its hedge funds.

The cost of insuring French debt is only 30 basis points higher than the cost of insuring German debt, which in Akel’s opinion is too low. (article continues below)

The manager has shied away from defensive corporate bonds, which trade at lower yields than French government debt, including France Telecom, as they will be sensitive to a spike in French yields.

According to Akel, a France downgrade could have a wider effect on eurozone government debt as “it’s supposed to be one of the two countries bailing out Europe”.

In particular, the AAA rating of the European Financial Stability fund (EFSF) depends on extensive backing from AAA issuers, which would diminish if France were to be downgraded.

Investors are worried authorities may have to deploy the fund in the event of a bailout of peripheral states like Ireland.

Ireland, which recorded negative growth in the second quarter following an austerity package, is running down cash to bail out its banks and avoid relying on international lenders.

If the EFSF has to bail out ­Ireland and calls on funds from France, the case for a French ­downgrade may strengthen.

Conversely, if France is downgraded, the EFSF’s ability to bail out Ireland will be limited.

Lucette Yvernault, the global credit portfolio manager at Schroders, which criticised the make-up of the EFSF last week, says France faces problems cutting its
8-10% budget deficit because Sarkozy’s party no longer controls the Senate.

The country also faces off balance sheet pension liabilities and declining contributions to its national pension plan, she says.

“The population is aging in France and contributions to the state pension plan are not rising. It’s not surprising that len0gthening the number of years’ contribution to the pension plan is being discussed.”