Why Bond Investors Prefer Spain to France – Reuters

By Yoruk Bahceli and Belén Carreño

Investors are increasingly demanding higher returns to lend to France compared to Spain, as they express concerns over France’s struggling finances while favoring Spain’s robust economy.

Supporters of Spain have been further validated following the unexpected elections in France during June and July, which have negatively impacted recovery expectations.

This shift is significant, as Spain, once considered one of the euro zone’s weaker economies, is now perceived as a safer option than the euro zone’s second-largest economy.

Here are four reasons why Spain is currently outperforming France:

1. Milestone
   Last week, the yield on France’s 10-year government bonds exceeded that of Spain’s for the first time since 2008. Recently, it was about two basis points lower than Spain’s. This is notable, especially given that the bond yield difference exceeded 500 basis points during the peak of the euro zone debt crisis in 2012, which led to a European bailout for Spanish banks.

As Gareth Hill, a portfolio manager, noted, many investors are moving their investments from France to Spain. Hill believes that Spain may be on its way to achieving "semi-core" status among bond investors, a reputation that has traditionally belonged to France due to its high credit ratings and substantial bond market.

1. Purse Strings
   France’s budget deficit is at risk of surpassing 6% of its economic output, which is twice the European Union’s 3% threshold. Investors are skeptical about significant progress being made under a minority government that is now scrambling to implement spending cuts and tax increases.

Conversely, the EU anticipates that Spain’s deficit will align with the 3% target this year, and does not recommend punitive measures for Spain as it has for France. Although Spain’s government also lacks a majority, this has inadvertently helped maintain fiscal discipline.

Teneo, an advisory firm, predicts that Spain’s previous budget will be extended for the second consecutive year, marking the sixth extension in a decade, thereby constraining spending. Additionally, Spain has reduced its debt more swiftly than France has in the post-pandemic era, with expectations for debt to decrease to under 103% of output this year, down from approximately 120% in 2020.

1. Booming Growth
   Spain’s economy is growing at a pace faster than France’s, driven by a thriving tourism sector and a strong labor market propelled by immigration. Spain’s economy expanded by 2.7% last year, nearly seven times the euro zone average, compared to a mere 1.1% growth in France. The French government expects the same 1.1% growth for this year.

In contrast, Spain’s central bank forecasts a 2.8% growth rate for this year, significantly higher than the initially projected 1.9%. The EU’s COVID recovery fund plays a critical role, with approximately four times more funds allocated to Spain than to France.

Morgan Stanley’s chief European economist highlighted that while it’s challenging to foresee Spain entering extensive fiscal expansion or severe austerity, its robust growth is beneficial.

1. Scorecard
   Despite its lower debt and more favorable growth trajectory, Spain’s credit ratings still fall several notches below France’s, with agencies assigning ratings between A/Baa1/A-. Both countries lost their AAA ratings between 2009 and 2012.

However, Spain, having been downgraded to as low as BBB- (just above junk status), has since seen multiple upgrades from S&P and Moody’s, while France has experienced only downgrades.

Market trends often lead credit ratings, as noted by an expert in euro rates strategy, suggesting that the convergence in bond yields indicates the market view that Spain is starting to catch up to France in terms of creditworthiness.