(Bloomberg) — It will take a lot more than political chaos in the European Union’s second-biggest economy to upend the rally in the continent’s bonds.
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While French President Emmanuel Macron’s decision to call a snap election caused yields to spike across the continent, sovereign bonds in the southern countries traditionally considered the most risky quickly rebounded.
Investors at Vanguard Group Inc. and Jefferies International view any contagion to periphery bonds as a buying opportunity, while BlackRock Inc. and Pacific Investment Management Co. founder Bill Gross are sticking with wagers the bloc’s debt will outperform the US.
The calls underline how attractive Europe’s sovereign bond markets have become to international investors since expectations for the European Central Bank started to diverge with the Federal Reserve on the speed of interest-rate cuts. Back in April, the yield premium paid by US Treasuries over equivalent German bonds — the region’s safest debt — climbed to the highest in five years.
“Widening French spreads present a good opportunity to add to periphery European exposure,” said Ales Koutny, head of international rates at Vanguard.
The spread between Italian and German 10-year bond yields jumped to its highest level since February after Macron’s announcement. Before the recent selloff, optimism that Italian Prime Minister Giorgia Meloni is prepared to work with instead of against Brussels helped narrow the gap to a two-year low.
Spain narrowed its yield gap over France and there’s now less than 20 basis points between them at the 10-year point of the curve, the least since the global financial crisis. The Iberian country has emerged as a market darling this year thanks to an economic rebound and long-term reduction in public debt. Meanwhile in Greece, Prime Minister Kyriakos Mitsotakis said this week the country plans to repay its bailout loans ahead of schedule.
Macron’s announcement “triggered some contagion, but when volatility stabilizes the risk will remain very specific to France,” said Alexandre Caminade, CIO for core fixed income at Paris-based Ostrum Asset Management. The crisis will likely highlight France’s poor fiscal backdrop, boosting confidence in countries with more favorable outlooks, he said.
S&P Global Ratings downgraded France’s sovereign credit score last month, citing the government’s ballooning budget deficit. Macron’s surprise move came after his centrist party was trounced by Marine Le Pen’s right-wing National Rally in elections to the European Parliament and polling suggests that her party will also achieve first place in the parliamentary vote. Le Pen has long advocated for economic policies that would further inflate state liabilities.
Vanguard’s Koutny had already been betting against France ahead of the election announcement given the country’s worsening fiscal backdrop, preferring to hold Spanish and Greek debt.
Wei Li, global chief investment strategist at BlackRock, says that aside from France, the overall fiscal trajectory in Europe is better than in the US. Pimco’s Gross pointed out in an interview on Bloomberg Television this week that uncertainty around the November presidential elections in the US will significantly impact Treasuries, making European bonds more attractive.
Not all asset managers are as sanguine. David Roberts, head of fixed income at Nedgroup Investments, sees too little value in European government bonds to compensate for the risk and volatility, given it’s still early days in the election campaign.
“Good luck to those who own French, Italian or Spanish debt over the next few weeks,” Roberts said. “It might be an opportunity to add value. It’s currently certainly a threat to losing it.”
Previous French election campaigns have caused a selloff in periphery debt because investors were concerned a Le Pen victory would lead to France trying to leave the European Union. But the chaos of Brexit has undermined rhetoric around exiting the bloc, likely removing that particular risk from the table at next month’s vote.
That makes it “a French story and not a euro-wide story,” according to Mohit Kumar chief strategist and economist for Europe at Jefferies. He’s had a short recommendation on French debt since the start of the year and advises buying Italian bonds to take advantage of the wider selloff.
“We’re not in a 2017 scenario where a vote for Le Pen was seen as a proxy vote on EU membership,” said Gareth Hill, portfolio manager at Royal London Asset Management. “It may make further EU integration harder, with more conditions attached, but I can’t see it leading to fragmentation.”
–With assistance from Naomi Tajitsu, Sujata Rao and James Hirai.
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