French regulator warns of sovereign bond bubble

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A top French financial regulator warned on Thursday that a bubble might be emerging on government sovereign debt markets.

The warning came from the head of the French financial markets authority (AMF), Jean-Pierre Jouyet, in remarks on French BFM radio against a background of a rise in some benchmark government bonds, which has the effect of pushing down the fixed yield or interest payment on such instruments.

"There is a paradox," Jouyet said.

"There is still an extremely high level of debt carried by states. And never has the level of investment in fixed-interest instruments, given the aversion to risk regarding shares, been so high.

"This means ... that a bubble is in the process of being formed.

"That means that states, which remain very indebted, are going to be able to raise finance at lower and lower cost: why should they stop (borrowing) suddenly? This is a real issue."

Governments issue debt, to borrow money from savers, at a fixed interest per year for a fixed period, the benchmark in Europe being 10 years.

But these bonds, in effect a right to a fixed income stream, rise or fall in value and this automatically changes inversely the yield in percentage terms for people holding or trading the bonds.

For example, the price of bonds will rise if there is a flow into them out of riskier investments such as shares, which usually offer, overall, the potential of a higher rate of return.

As demand for the bonds rises, the price rises and the fixed interest as a percentage of the new price falls.

The yield on the eurozone benchmark or best-performing bond, the German 10-year Bund, fell late on Tuesday to a record low point of 2.112 percent. The yield on 10-year US and French debt has fallen to about 2.5 percent.

Some analysts hold that such low yields are out of step with fundamental pressures and risks in economies and also reflect pessimism about the outlook among investors and people with savings to spare, otherwise described as risk aversion.

© 2010 AFP

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