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Why You Should Buy French Bonds

Tuesday, 5 Feb 2013 | 7:38 AM ET

After several weeks of improved sentiment, yields on Italian and Spanish bonds spiked this week amid political uncertainty. But instead of fleeing to safe havens, investors may seek a halfway house in French sovereign bonds, analysts told CNBC.

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Alleged secret payments to Spanish Prime Minister Mariano Rajoy and election polls in Italy showing former prime minister Silvio Berlusconi gaining ground have unsettled investors once again.

Interest rates on Spanish 10-year benchmark bonds ticked up to 5.5 percent on Monday after being at lows of 4.9 percent in mid-January. Italy's 10-year debt yield crept up to 4.5 percent after nearing the 4 percent level last month.

But ultra-low yields in safe-havens such as Germany give negative real interest rates when allowing for inflation, while talk of a "bond bubble" in longer term paper has worried some investors . As a result, fixed-income investors can be left scratching their heads.

(Read More: Danger in Safety? The Risks in Core Europe's Bonds)

"French debt offers yield-hungry investors a very significant yield pickup over Germany, while also being a very liquid market with supply offered in regular opportunities. It also tends to be lower volatility, with its spread over Germany acting as a buffer in times of spread-tightening," Peter Chatwell, fixed-income strategist at Credit Agricole told CNBC.com.

Nicholas Spiro, managing director at Spiro Sovereign Strategy agrees. He told CNBC.com that the resilience of French debt should not be underestimated.

"The very definition of safety is undergoing a shift as "core" government bond markets come under pressure. France's saving grace, however, is that it boasts a deep, liquid and relatively safe debt market which acts as a 'second-best' alternative to German paper."

(Read More: Most French People Want 'Les Rosbifs' to Leave EU)

Growth in France looks set to be 0.2 percent for last year and not much better this year with forecasts of 0.4 percent, according to Eurostat. The government's budget deficit is also high, with a target of 4.5 percent of GDP (gross domestic product), but it appears favorable compared to Spain or the U.K.

With the austerity measures touted by French President Francois Hollande, such as the 75 percent tax rate on high earners, borrowing could fall pretty sharply this year. Jennifer McKeown, senior European economist at Capital Economics says this could have knock-on effects however.

(Read More: French Government Denies Dropping 75% Tax Plan)

"Austerity measures will hit consumer spending this year and structural factors (particularly labor market rigidity) are holding back competitiveness. These factors mean that the French economy is likely to contract this year making deficit reduction more difficult."

French debt certainly looks considerably less risky than that of Italy or Spain, according to McKeown, although financial markets haven't considered that French banks are heavily exposed to Italian banks, she said.

"France continues to lose ground to Germany in terms of competitiveness and is very unlikely to generate meaningful growth for some time," Spiro said, echoing McKeown's comments.

"However, a bond market rout is very unlikely because of the idiosyncrasies of the French sovereign debt market."

By CNBC.com's Matt Clinch

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