24th April 2012
Investors seeking safe havens for their money have been left chasing lower bond yields elsewhere.
Sarkozy falters in France
On Sunday, the French voted firmly against bearing the burden of cuts. In the first round of the French elections, current president Nicolas Sarkozy, who banded together with Germany's Angela Merkel to create the "Merkozy austerity pact", was beaten into second place by Francois Hollande, a socialist who has pledged to renegotiate this EU treaty on debt and deficit reduction.
Meanwhile one in five voters backed Marine le Pen, the far right candidate who campaigned on an anti-Europe, anti-immigration and anti-globalisation agenda.
Why Francois Hollande could be disastrous for the eurozone
The Business Insider blog has highlighted the election pledges by Francois Hollande that could "terrify the rest of Europe", should he win the French presidential race, such as bringing the retirement age back to 60 from 62, and balancing the budget by increasing spending rather than implementing cuts.
Even if Sarkozy eventually triumphs over Hollande in the forthcoming run-off elections, he may have limited political leeway to force through deficit-cutting measures, following the surge on the nationalist far-right. Mindful Money has previously reported on how French austerity measures, when combined with a slowing economy, will start to bite.
Austerity measures oust Dutch PM
Meanwhile in the Netherlands, the Dutch coalition government collapsed after failing to agree on how to implement £12 billion in cuts. Prime Minister Mark Rutte tendered his resignation after the far-right Freedom Party walked out of talks, paving the way for elections later this year.
Erik Neilsen, chief economist at UniCredit, was reported as saying that the events in France and Netherlands were "reactions against incumbents' handling of the crisis, plus poor economic outlook and prospects. It takes time to restore growth after these kind of crises, but people are impatient."
Henderson Global Investors commented that proposed austerity is giving credence to more extreme and unpredictable politics, saying: "With elections in Greece and more likely the Netherlands in the near future, this is a trend which could create volatility at a time when Europe needs consistency and stability."
Implications of budget deficits on borrowing
The budget deficits for France and the Netherlands both breach new EU rules requiring eurozone governments to stay below 3% of gross domestic product (GDP). The Netherlands Central Planning Bureau estimates the country's public deficit will rise to 4.7% of GDP, while France is running with an annual 5.2% deficit. If the European Commission levies fines for failing to bring the deficits in line, the borrowing costs for both countries could spiral.
However, today's auction of Dutch bonds proved successful. The Dutch State Streasury Agency sold nearly €2 billion of bonds, right in the middle of its target of €1.5 billion to €2.5 billion of debt, at average yields of 0.523% over two years and 2.782% over 25 years.
Unlike the Netherlands, Spain, a more troubled member of the Eurozone, subsequently saw its borrowing costs almost double, even on short term debt. The yield on Spanish three-month debt went up to an average yield of 0.634%, compared to 0.381% a month ago. The six month bills sold at an average yield of 1.58%, up from 0.836% last month.
Falling markets and bond yields as investors seek security
Shares in Europe's biggest companies suffered as investors sought safe havens for their money. The market reactions by the end of Monday, as reported by The Daily Telegraph, saw the Stoxx Europe 600 index sink by 2.3pc to its lowest level for three months. The German Dax dropped 3.4pc, while France's CAC and Spain's Ibex were down 2.8pc each. In London, the FTSE 100 closed down 1.9pc. In the US, the Dow closed down 0.8pc, the S&P 500 lost 0.8pc and the Nasdaq shed 1pc.
The demand for the security of German government bonds pushed yields down to record lows of 1.584%. Meanwhile investors keen avoid Eurozone turmoil opted for what Reuters described as "the ultimate safety play" of US government bonds. As a result, the yields on 10-year U.S. Treasury notes fell 4 basis points to a seven-week low of 1.921 percent.
More from Mindful Money:
Sign up for our free email newsletter here, for your chance to win an Amazon Kindle Touch.