France’s top rated corporate bonds are trading inside OATs of the same maturity, strongly suggesting that investors see some the country's companies as less risky an investment than the sovereign. Some in the corporate bond market are warning that it could change the way French companies approach the market in next month.
This comes after a chaotic week in politics that ended in the French government's collapse and president Emmanual Macron making an address to the country in which he vowed to see out his term, which is due to end in 2027.
On Wednesday after market close, Michel Barnier’s minority government collapsed after the country’s parliament passed a vote of no confidence in it. This is the first time this has happened in France in more than 50 years.
Barnier’s downfall came as the result of his attempt to push though parts of the 2025 budget without taking a vote from parliament.
As France's budget deficit has risen, so French govvie spreads have been widening for most of the year, with 10 year OATs starting 2024 just 55bp back of Bunds, but up to 87bp wider earlier this week. On Thursday the spread was around 80bp.
At the same time, some French corporate bonds have not widened in sympathy and are quoted tighter than OATs.
“It’s not something that’s supposed to happen and opens up all sorts of questions about where investor demand is going to go,” said a corporate syndicate banker in London. “Spreads for company X may be tighter than OATs, but is anyone really convinced that an IG company is less risk than a core European sovereign? I don’t see it.”
But a banker covering public sector clients disagreed. “I would rather leave my money with LVMH than with the state," they said. "That’s what the spread differential tells you at the end of the day, and the risk premium is there.”
Top names trade through
On Thursday afternoon, the 10 year bonds of Sanofi, Schneider Electric and LVMH Moët Hennessy Louis Vuitton were trading inside Aa2/AA-/AA- rated 10 year French sovereign debt.
Pharmaceutical company Sanofi, rated A1/AA/AA, was the furthest through, with its €500m 1.25% March 2034s at a mid-market yield of 2.73%, compared to 2.91% on the OATs, according to Tradeweb.
Schneider Electric’s A3/A rated 10 year debt was 3bp inside the OAT, while LVMH’s Aa3/AA- rated 10 year debt was 13bp inside.
Against swaps, LVMH’s 10 year was at mid-swaps plus 74bp, while the 10 year OAT was 77bp-80bp over, according to a senior French SSA debt capital markets banker.
In the days before the French government collapsed, a handful of other French companies were trading inside the sovereign curve, with Air Liquide’s 10 year bonds, and L’Oreal and Danone’s five year bonds all bid tighter than OATs.
“It’s spectacular”, said the senior SSA DCM banker. “But what does it really change?”
The banker pointed out that the same has happened in Italy, while others also highlighted that Spanish and Portuguese corporates have traded inside their sovereigns.
“It’s part of the new way of looking at things,” said a senior corporate syndicate banker in London. “France is now the basket case. Are the [eurozone] peripherals even a thing anymore? Not really. No one isn’t buying Spanish or Italian credit because they’re worried about the country’s debt.”
While corporate bankers might be getting sniffy at the state of French sovereign debt, others are calmer. “France might have a lot of problems, but it is still a AA- rated government,” said Felipe Villarroel, a partner, portfolio management, at TwentFour Asset Management. “OAT spreads are not a million miles away from the average for investment grade corporate bond indices, so there is plenty of bad news already priced in.”
Rating on the line
France’s Aa2/AA-/AA- rating might not last for much longer, warned a credit and covered bond trader.
Given how unstable French government has been and its projected deficit, he thinks a French sovereign downgrade is "very likely next year".
That may mean it will become "unsurprising to see French covered bonds, even if they have a slight disadvantage to govvies, easily trade through OATs", he said.
While he compared that to Italian covered bonds trading through BTPs, he also cautioned that the French covered bond market was much larger than the Italian one.
Away from covered bonds, French bank spreads do not look like they will be following corporates through the OAT curve.
The credit trader said that "everyone is looking at senior versus covered, senior preferred to non-preferred, and French bank spreads are incredibly expensive”, adding that "due to the big [government bond-swap spread] moves they have widened and still are attractive versus swaps, but they are not great versus OATs."
A weight on corporates
Perversely, the strength of French corporate spreads and yields might work against the borrowers come January, when many will be expected to bring new bonds to market.
“If you’re looking at what’s available to buy, you’re going to need a very compelling reason to buy a corporate at a lower yield than the sovereign,” said a corporate DCM banker in London.
High grade corporate bond spreads have been tightening all year, as a surplus of cash in the asset class kept demand higher than supply. Up to October, there were only three weeks of net outflows from IG credit funds in Europe, and all three were for less than €1.5bn.
“You’ve got to think that corporates are at these near record tight levels, and the sovereign is 30bp wider than where it was at the start of the year, so which way are these trades likely to perform?” said the banker, "The downside for buying low beta credit is much higher than the upside from buying rates.
“There will be a bleed of money from credit to rates in France, especially at the low beta end,” he said. “You might see borrowers there needing to pay a higher new issue concession come January than they would have maybe expected to.”
A second corporate banker in London agreed, noting that highly rated French companies might even wait until later in January before bringing deals. “The headline spread is a bit more of a challenge if OATs are trading wider,” he said.
Helped by supply
Still, the fallout might be limited. Schneider Electric sold €1.3bn of bonds across two maturities, alongside a handful of lower rated French companies, in January, according to GlobalCapital’s Primary Market Monitor.
LVMH waited until May before it brought a deal, and Sanofi has not been in the euro bond market since 2022.
In France, the political turmoil is not expected to cause a major shift in the way the country operates. This is in part because the French constitution means that the government will not come to a standstill because the 2024 budget will be rolled over into next year’s if a new budget is not approved by the end of the year.
“Extreme scenarios seem unlikely,” said Villarroel at TwentyFour. “From a markets perspective, the worst-case scenario here is far less damaging than previous examples of government budget stand-offs, such as those over the US debt ceiling, where a technical default was the worst-case, or Italy’s situation a few years ago where there was a small threat of a euro exit.”