France's five-year sovereign EDF (Expected Default Frequency) 1 has worsened in 2017, rising from 0.1% at the start of the year to 0.16% in the week ended February 10. This EDF measures the probability of the French government defaulting on a bond over the next five years. In September 2016 the metric was just 0.06%. The current EDF maps to a market-implied rating of A3, putting it four notches below the Moody's Investors Service rating of Aa2. The bump up in France's EDF was driven by an increase in the spread on CDS contracts, with the five-year CDS spread rising from 38 bp at the start of 2017 to 55 bp on February 10. The Market Sharpe Ratio, which is the other key driver of the sovereign EDF, was slightly lower over this period. The increase in France's sovereign EDF can be attributed in large part to recent comments by National Front party leader and presidential candidate Marine Le Pen outlining broad policy proposals. Ms. Le Pen stated her intention for France to leave the euro zone and redenominate the majority of its ª2 trillion in sovereign debt into newly-formed francs. This would probably constitute a sovereign default, particularly if the franc fell against the euro (which it probably would), triggering CDS contracts to be paid. The next presidential election is expected to be held across April and May. Opinion polls suggest that Le Pen is the most popular single candidate, but she is unlikely to be able to form a majority at the second round election. Nevertheless, the possibility of a Le Pen victory cannot be dismissed and any subsequent implications for sovereign default risk are now priced in. The one-year sovereign EDF has been unchanged at 0.01%, suggesting that the rise in sovereign risk lies beyond the one year horizon. The government bond market, which is driven by many of the same factors as the CDS market, has moved in a similar direction so far in 2017. The French 10-year government bond yield rose from 0.68% at the start of the year to 1.05% on February 10. Moreover, while French and German government bonds tend to move in lockstep, with a fairly constant spread, reflecting the higher risk premium on French government bonds, this spread has risen from 47 bp to 73 bp since the start of the year. This reflects the increased risk premium on France's government bonds, in excess of Germany's, over the past couple of weeks. http://www.surveygizmo.com/s3/1133212/Rate-this-research?pubid=1059750 Sovereign EDF TM (Expected Default Frequency) credit measures are forward-looking probabilities of default extracted from credit default swap spreads. Spot CDS spreads are adjusted for loss-given default and the market price of risk to arrive at estimates of actual future default risk.
