As France grapples with continued protests, high government debt, and growing speculation from economists about whether the country is on the verge of another euro zone crisis, Canadian investors and borrowers watching government bond yields rise worldwide are raising concerns.
“France’s government bond yields have risen more sharply than those of the United States and many other developed economies during the recent sell-off. The underperformance reflects growing concern about political uncertainty and a weak fiscal outlook,” said senior economist Vikram Rai at TD Bank in a statement on Wednesday.
“France stands out among its developed-market peers in the recent global bond sell-off. Long-term yields have risen across major markets, but French government bonds have seen an outsized move.”
Bonds are loan investment products issued by governments and companies over fixed terms, and over the course of that term, the bond pays a regular yield or interest payment to the owner. Bond yields fluctuate regularly based on a combination of various economic factors, as well as supply and demand.
Since the start of the year, especially since the Iran war began, bonds have been selling-off, which has driven up their yields in order to win back investors.
The U.S. Treasury yield has shot up over five per cent in recent months, and some French government bonds are following in lockstep.
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What’s going on in France?
France’s government, like many others around the world, has a debt problem.
The nation’s sovereign debt is now close to 120 per cent of its GDP, which means a substantial amount of revenue the government brings in, including from taxes, goes just to paying the interest on the money it’s had to borrow. Those rising interest costs are putting pressure on the government’s public finances.
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If investors are losing confidence in a government’s ability to pay off its debt, they may sell their bonds because of perceived risk.
Another potential concern for investors, in this context, is the fact that France is about to go into an election period, which dials up the uncertainty about the country’s future financial strategies.
“The French government debt is like 120 per cent of GDP, and that is twice as high as what it’s supposed to be by the EU standard, and I think investors are more concerned about the future prospect,” says finance professor Yoshio Nozawa at the University of Toronto.
“If the populist leaders are elected, the deficit problem is expected to be even worse. So, this combined effect is contributing to the concern about the French government’s ability and willingness to narrow the gap between what they are spending and how much they are raising in tax revenue.”
Rai notes how the 10-year French government bond, known as the Obligation assimilable du Trésor (or OAT), is hovering at close to five per cent, which is the highest level since 2002, and up from about 3.5 per cent in June.
The 10-year U.S. treasury yield was about five per cent as of publication, and although that’s down from a recent peak of 5.3 per cent, it’s still up from roughly four per cent in March.
Meanwhile, the 10-year Canadian bond yield was about 3.8 per cent, and up from just over three per cent in March.
“The bond sell-off took a darker turn this week, with yields in much of Europe suddenly ratcheting higher, especially in France,” said Doug Porter, chief economist at the Bank of Montreal in a note to investors from Oct. 2.
“That nation has seen its 10-year yields jump more than 100 bps [one per cent] just since early August amid mounting fiscal concerns.”
Both Porter and Rai note how the spread, or difference between France’s and Germany’s 10-year yields, has increased to over 1.5 per cent in recent weeks, the highest since the euro crisis peaked around 2011/2012.
At the time, Greece was facing massive sovereign debt problems, which raised fears of wider financial instability and threatened the future of the euro as a currency.
Nozawa says that although this may be reminiscent of that euro zone crisis, France’s economic positioning means there may be less cause for concern right now.
“That [Euro zone crisis] was a very serious concern at that point in time, and that serious concern spills over, not just to the Greece government, but to Italian and Spanish governments, and investors are concerned about similar things that may happen to other more vulnerable European members,” says Nozawa.
“But here, in terms of France, it’s a big economy and they are not Greece, and in that sense, it is worrying, in some respect, because it’s a big member of the EU, but in terms of the observed cost of borrowing and also the amount of deficit they have, we are not really talking about 2010.”
What does this mean for Canadians?
The Bank of Canada sets the floor for borrowing rates that commercial banks can offer loans to Canadian households and businesses, which usually affects variable rate loans. But longer-term fixed rate products are more often determined by global bond yields.
Even though France’s debt issue may not directly impact Canada’s economy, if France’s bond yields rise, so too may Canada’s in order to stay competitive.
But so far, Canadian borrowers may be in a relatively better position compared to the U.S. and France.
“Canadian yields have clearly felt the gravitational pull of rising global yields, but have mostly managed to remain calmer,” said Porter.
“Canada’s cooler growth backdrop, in part because of the trade tussle, slightly milder inflation, and less-fraught government finances have all played a role in dampening the yield back-up. Note that Canada’s fiscal sustainability is much less of an issue than for others.”
Nozawa says that regardless of Canada’s bond market performance compared to other nations, the relative cost of borrowing some loan products is still likely going to increase.
“The interest rates on long-term government bonds tend to move in lockstep across countries. So that is a tendency that we have and that is often explained by the fact that there are these big global investors who have a diversified portfolio consisting of Canadian government bonds, U.S. government bonds and French government bonds,” says Nozawa.
“When the interest rate of one thing goes up, the other thing has to go up so that they kind of strike a balance between these three.”
