REUTERS SUMMIT-French stasis unnerves global bond investors

Mike Dolan
Monday, 18 Nov 2013 | 2:50 PM ET

(For other news from Reuters Global Investment Outlook Summit, click on http://www.reuters.com/summit/Investment13)

* French problems seen as threat to euro zone

* Reuters summit hears concerns about French economy

* France falling behind southern European countries

LONDON, Nov 18 (Reuters) - A stagnant French economy and a dearth of much-needed French economic reforms are a weak link at the heart of the healing euro zone, heaping risks on hitherto stable French assets and the common currency, top global investors said on Monday.

Money managers from firms which collectively steer assets of about $1.25 trillion told the Reuters Global Investment Outlook Summit in London that economic and political stasis in the euro zone's second biggest economy was hard to price and trade but held significant threats to the bloc nonetheless

With French government bonds still ranked as "core" euro debt along with German bunds, the investors are concerned current yields - which at 2.17 percent on 10-year French bonds are less than 50 basis points higher than German equivalents - do not compensate investors for the outside chance of political shocks.

"France is a country that does need to change structurally," said Hans Stoter, chief investment officer at the $238 billion ING Investment Management.

And "the structural reform part is the challenging part. That is where the risk really lies for Europe."

Stoter reckons German-driven growth can paper over French economic deficiencies in the short term and euro breakup is not yet back on the radar. But his concern about the threat of a listing French economy was widely echoed.

Founder and CEO of $12 billion hedge fund CQS, Michael Hintze, told Reuters that rising social tensions, high government debt and an exodus of workers raised the chances of French disillusionment with the euro project down the line.

"What does worry me a little bit is what happens in France, because I think that's one that could be a major pothole in 2014," said Hintze, whose CQS Directional Opportunities fund rose 36 percent last year and is up 12 percent this year.

With restrictions in place on buying sovereign debt insurance in the form of credit default swaps (CDS), Hintze said he was instead buying CDS against French corporates, banks in particular, as a proxy play on the economic and political risks.

"When we've done our stress tests around them (the French banks) they're fine. (But) they're interesting enough for me to play the macro theme," he said.


Hintze isn't the first hedge fund manager to take a negative view of France. A number have bet, mostly unsuccessfully, against its government bonds during the white heat of the euro crisis over recent years.

But there's been little improvement in the fundamental backdrop to cheer the optimists.

Reports last Thursday showed the French economy shrank 0.1 percent in the third quarter of 2013, below expectations of 0.1 percent growth and recording a contraction now in three of the last four quarters. Earlier this month S&P downgraded France's sovereign credit rating for a second time.

What's more, a report on Thursday on French competitiveness, commissioned by President Francois Hollande from the Paris-based Organisation for Economic Cooperation and Development warned the economy is falling behind southern European countries that have cut labour costs and become leaner and meaner.

Hollande's public opinion poll rating fell to a new low of 20 percent in Ifop polls published this weekend, the lowest ratings for a French president since the poll started in 1958.

Hintze drew a contrast between Germany, which - despite being a major contributor to bailouts of the likes of Greece and Ireland - is largely in favour of the euro zone, and France.

"There's no question, Marine Le Pen (leader of the far-right National Front party) seems to be gaining popularity," he said. "If you contrast that with the Germans ... there is a consensus view. Germany is very much for the euro, a consolidated Europe and the European project. We'll see if France is."

Other more mainstream fund managers were similarly unnerved by risk of rising support for anti-euro parties and France's potentially equivocal position.

Pioneer Investments Group Chief Investment Officer Giordano Lombardo told the Reuters summit that political risks within the euro zone could well re-surface over the coming year and test the cohesion of the 17-nation area.

Critically, financial markets seem to underestimate that.

"The political risk is not priced in," said Lombardo at Pioneer, which is owned by Italy's Unicredit and has more than $230 billion of assets under management worldwide. "It is possible that a major anti-euro party gets a major victory in a European country."

Lombardo said popular resistance to the euro in countries such as France, Italy and the Netherlands - as well as within the hardest-hit bailout countries - could well find a voice in right-wing or populist parties and next May's European Parliamentary elections could provide a lightning rod.

And betting against low-yielding French government debt may be the best way to protect against such political jolt, he said.

"France is a bit worrying," said Lombardo. "Clearly France is not enjoying strong growth, which is an understatement, it has had very few reforms - less than Spain and Italy - and, on the other side, the bond market has been pretty benign."

"If one wants to take a hedging position towards Europe a safe way to do it is through the OAT (French government bond)."

Yet for those wary of failed trades of the past, the issue is less that France has a problem than the difficulty in seeing a trigger for change - or even a crisis that may bring it.

"Our concern around France is we don't see the same level of progress (as in Southern Europe) around the deficit and we don't see any changes in unit labour costs," said Andrew Wilson, Chief Executive at the $800 billion Goldman Sachs Asset Management. "We've been underwhelmed by the policy reactions."

But "from an investment point of view we need some catalyst to cause some widening in the French spread," he added. "It's quite hard to see what that catalyst might be. It doesn't mean it won't happen but at this stage I wouldn't say we can see anything on the horizon."

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(Additional reporting by Laurence Fletcher, Chris Vellacott, Sujata Rao, Julia Fioretti and Shadi Bushra; Editing by Giles Elgood)