French bonds weather downgrade as triple-A universe shrinks
* French bonds stable after Fitch downgrade to AA-plus
* Investors comfortable with AA due to limited AAA options
* Portuguese 5-year yields trade close to 10-years
LONDON, July 15 (Reuters) - French government bonds held steady on Monday after the country lost its last major triple-A rating last week, suggesting investors have come to terms with a shrinking universe of top-rated debt.
Fitch downgraded the euro zone's second largest economy to AA-plus on Friday, citing weaker economic output, rising unemployment, budget deficits and subdued external demand.
It kept the outlook stable ,however, meaning no further downgrades were expected in the next two years.
The move does not trigger forced selling by investors, who have become used to seeing even economies deemed safe havens, such as the United States and the UK, downgraded.
"Conservative bond investors, such as reserve managers, used to have triple-A only mandates but they have adapted to the reality that there aren't many triple-As anymore," said Nikolaos Panigirtzoglou, head of global asset allocation at JPMorgan.
"There is more acceptance from conservative bond investors and repo market participants for double-A. Moving to single-A would make a big difference but it would take many downgrades to get there and that is unlikely for the foreseeable future."
French 10-year bond yields were 2 basis points higher on the day at 2.20 percent, some 35 bps below 2013 highs.
Some analysts say France's downgrade may in the long term leave the lower-rated euro zone countries more vulnerable to the debt crisis as its credibility is impacted.
It is seen as a powerful supporter of demands made by the peripheral countries. Euro zone ministers agreed last month to French demands to allow the European Stability Mechanism bailout fund, to be used to help struggling banks.
"France remains one of the biggest economies in the euro zone, but on the other hand, if they get downgraded further they would lose their credibility," ING senior rate strategist Alessandro Giansanti said.
"We could see weakening support for the periphery going forward if France continues to weaken as well."
Portuguese yields stabilised after a sharp rise last week as Lisbon delayed the next creditor review of its bailout, with the opposition seeking a renegotiation of the deal.
The opposition's demands raise a hurdle to a cross-party pact the president said was needed to allow the country to return to markets next year.
Ten-year Portuguese yields were flat at 7.64 percent, while five-year yields were 3 basis points higher at 7.50 percent. The spread between the two hit its lowest since June 2012 earlier in the day at 13 bps.
When investors see risks a country may not fully repay its debt, they quote the bonds in prices instead of yields as they are more concerned about what they can recover than what their return might be. This is the case in Portugal.
They tend to price all maturities equally, meaning shorter-dated debt underperforms.
"It's hard to tell whether the political crisis in Portugal will lead to a relaxation of the fiscal measures (of the current deal), a second bailout or debt forgiveness," said Marius Daheim, chief strategist at Bayerische Landesbank.