Everyone seems to be waking up to the record spread between French bonds and Bunds at the moment. Having risen in July, it’s reached another record eurozone high on Wednesday of 81bps. French yields are low but clearly the debt is under-performing.
Is 100bps too far off?
No — actually the more Italy and Spain worsen and therefore the guarantees they provide to the EFSF look dodgier (especially if it gets used to prop them up and they step out), the more France is sucked in. Divyang Shah of IFR Markets puts it really well:
Italy and Spain have seen their contribution to the EFSF go up from 18% and 12% to 19% and 13%, respectively, without Greece, Ireland and Portugal. For Germany and France the increases have been from 27% and 20.5% to 29% and 22% respectively. But the market pressure on Italy and Spain has seen both enter the spotlight and if they decide they cannot contribute, then the funding required from Germany and France would go up to 43% and 32% respectively. Given the total of 75%, it would be hard to argue that we don’t already have a transfer union for the Eurozone.
The 10-year spread on France/Germany has widened out beyond its July peak to its widest level since mid-1990. The 10-year spread on Belgium/Germany has broken through 200bps and currently at 203bps is close to breaking its record wide level just under 215bps from early 1999. Both are significant, but especially so the moves seen in France. It suggests that investors no longer regard it as part of the core and have been for the last few weeks trimming exposure.
When a country steps out of its guarantee, the shortfall is shared between all the other guarantors – not just France and Germany. The point is though that their shares are huge already. We hate to resurrect the cliché… but this is another single point of failure like Italy itself. Any system that has multiple SPOFs is in trouble.
And it basically goes back to this thing when you consider that France’s AAA rating might also be a point of failure…
For instance, the IMF’s recent Article IV staff report on France forecast that debt to GDP would reach 85-95 per cent by 2013, depending on fiscal reforms, interest rates and growth, but not counting contingent liabilities from the EFSF. If France’s EFSF guarantee did rise to 32 per cent of total guarantees (to around €250bn) it seems to work out around 10 per cent of GDP. Not entirely reassuring. Some IMF AAA charts to close:
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