The past two weeks have seen dramatic political and economic events in the euro zone that have sent the prices of many assets tumbling. But if we can personify the French sovereign bond market, it has merely reacted with a Gallic shrug and a rhetorical question: “Crisis? What crisis?”
France’s government bond yields have reached safe-haven prices despite the dramatic ousting of a centre-right president in favor of a socialist, François Hollande, who was sworn in on Wednesday after winning the second round of the presidential election a few days earlier. At 2.85 percent when European trading ended on Friday, the yield on the benchmark 10-year offered a paltry real return of 0.25 percent after subtracting euro zone inflation of 2.6 percent. The French 10-year was 24 basis points lower than on the eve of the election’s first round in April, which established Hollande as the clear front-runner.
The French bond market has found strong support from a progressively clearer realization that despite his calls for more emphasis on growth, Hollande is not going to tear up plans by Nicolas Sarkozy, the erstwhile president, to close France’s fiscal gap. Hollande has merely decided to postpone by one year, to 2017, the target of eliminating it completely. The new regime’s fiscal credibility was underlined by his Thursday appointment as finance minister of Pierre Moscovici — a safe pair of hands — who promptly announced “public debt is an enemy of the country.”
In addition to Moscovici, most of Hollande’s cabinet appointments last week were equally soothing to financial markets. Fears that Hollande would be a highly interventionist president, imposing an antibusiness left-wing regime in the Fifth Republic, were eased by the decision to appoint as prime minister the moderate Jean-Marc Ayrault. Markets also found reassurance in Hollande’s omissions as well as his commissions: Martine Aubry, who devised France’s 35-hour working week, was not given a cabinet post.
Hollande garnered blanket international media coverage in recent weeks because of his insistence that the EU needed to emphasize pro-growth policies as well as austerity. A year ago this would have unsettled bond markets. But in 2012 this has reassured those bond investors fearful that excessive austerity would provoke an economic crisis, followed by a fiscal one, in France as it has in Spain and Greece, and in Ireland’s recent past.
The biggest worry for bond investors is not whether Hollande is going to do too much, but whether he is going to do too little. Michel Martinez, economist at Société Générale in Paris, says it is “hard to identify flagship measures in his program” that go beyond “a handful of symbolic moves” such as the 75 percent tax on incomes above €1 million ($1.3 million) a year. This won headlines but is unlikely to generate much revenue, because European history shows that rates as high as this trigger aggressive tax avoidance. Where does there need to be more meat? Martinez says: “Mr. Hollande recognizes the need to enhance France’s competitiveness and labor market performance, but his proposals appear insufficient to boost GDP [gross domestic product] trend potential growth.”
France’s GDP growth was sluggish even before the credit crunch — in the past ten years it has never risen above 2.7 percent. This is bad for the Fifth Republic’s fiscal position because it inhibits growth in tax revenue. Economists blame France’s unimpressive long-term progress in boosting output largely on high labor costs and an inflexible labor market, which have left it with a persistent structural trade deficit among other problems. Sarkozy made initial progress when in office in implementing measures to make French working life more efficient — using the tax system to increase incentives to work extra hours, for example — though the pace of reform slowed considerably in his last years in office. Hollande has been resolutely silent on reforming the labor market — aside from a partial restoration of the retirement age of 60, which will add to rather than reduce France’s fiscal burden.
The French bond market may therefore remain stable in the short term. But given the country’s structural lack of competitiveness, life for French bond investors may well become more exciting — or terrifying — over a longer time horizon.
