Transcript of Interview with AFT’s Cyril Rousseau on 03 May 2023

17 May 2023

By Xavier D’Arcy – PARIS (Econostream) – Following is the full transcript of the interview conducted by Econostream on 03 May with Agence France Trésor Chief Executive Cyril Rousseau:

Q: Could you give us an indication of how your funding activities have been going so far this year? Are you happy with the results so far?

A: Our funding activities have been successful so far. We have already issued more than 40% of our target for 2023, which is consistent with our historical performance. We access the market regularly through auctions and strive to be predictable. The current market conditions are favorable for us to implement our strategy. The main difference is that we are now in a 3% yield environment compared to a 0% yield environment two years ago.

Q: France’s recent pension reform has been welcomed by rating agencies and the OECD, with many saying it improves the outlook for the economy and public finances. But the reform also caused considerable political and social turbulence across the country, which has been a cause for concern. If we look at the Fitch report from last week, which downgraded France’s credit rating, they mentioned the social tensions and high expected deficits, despite the reform. Are you noticing more volatility due to recent developments? Or are the net effects positive?

A: The recent volatility in yields is mostly due to other factors such as uncertainty surrounding inflation and monetary policy, as well as the banking crisis that began in March. The decision made by Fitch is based on different assumptions about our growth prospects and debt trajectory. However, the government is committed to reducing the debt-to-GDP ratio and disagrees with Fitch's analysis. Now, what we have to see is what the assessment of investors is, and this is what you can assess by looking at the market.

Q: Has the milder-than-expected energy situation this winter reduced your funding need? Will the French price shield be smaller than expected? How would you adapt your issuance if this were the case?

A: There are two main considerations with regards to the impact of recent events on our funding plan. The first is whether there will be an impact on the price shield, and the second is whether it will affect our issuance of medium and long-term debt. Our aim is to maintain predictability and transparency in our funding plan and avoid changing our targets during the year unless absolutely necessary. In 2020, we made an exception due to the shock caused by the pandemic and the support from the ECB. Our strategy is to prioritise our medium and long-term programme, and make adjustments to short-term debt first, if necessary. We do not expect any changes to our funding plan for 2023 at this time, as we did not change it even in 2022 despite the crisis caused by the invasion of Ukraine in March.

Regarding the impact of the mild winter on the energy shield and its cost, it is not straightforward to translate market prices into fiscal costs for France. Our energy mix is unique, and a significant portion of the energy shield was funded by excess profits made by renewable and nuclear energy producers due to high prices. The lower energy prices have balanced out the extra subsidies provided by the state. Also, regulated prices are not set the same way as market prices. In 2022, despite the crisis, we had a lower fiscal deficit than expected. Overall, we aim for a stable funding program, with slight adjustments as necessary.

Q: This week sees the introduction of the ceiling of €STR minus 20bp on the remuneration of government deposits in the Eurosystem. How do you think markets are reacting to this? What implications does the new ceiling have for France’s funding activities?

A: The ECB made an exceptional decision in September to temporarily provide remuneration on central bank deposits to mitigate the impact of exiting the zero-interest rate environment on money markets. This decision has had a direct impact on us, as we typically invest state cash in the money markets. However, due to the zero-interest rate environment and excess liquidity, we had stopped doing so and held cash in the central bank account. Now that the remuneration has changed, we have resumed our operations and started investing cash in the money markets again. It seems that our actions, along with those of other cash managers, have not destabilised the market. So far, the ECB's gradual step-by-step strategy appears to be effective.

Q: The German Federal Finance Agency DFA has taken a couple of steps to address collateral scarcity. Have you seen any disruption in your market functioning or have you seen a higher use of the primary dealer repo facility recently?

A: We have a primary dealer repo facility, which was not utilised in 2022 despite the collateral crisis. This indicates that there was no scarcity of collateral in the French debt market, and primary dealers did not have an incentive to request securities from us for this facility. One reason for this could be that the central bank did not hold as much French debt as German debt. Another reason could be that Banque de France was willing to lend its portfolio of securities, which was sufficient to balance the demand for collateral from the market without requiring us to intervene. This lack of demand could be attributed to the policies of Banque de France and the higher share of Germany's debt at the ECB compared to France's share.

Q: How would you assess the impact of ECB QT so far on the market? Does a potential increase in speed worry you in any way?

A: I don't want to discuss the monetary policy hypothesis, but I can explain the current situation. Previously, the central bank bought 70% of what we issued. However, we have now moved to single digits, with only the reinvestment of PEPP and part of PSPP. This change has resulted in higher yields, which has attracted investors that replaced the central bank in the distribution of the debt. So, we have witnessed a shift in investor distribution due to the increasing yields. There was a concern about whether there would be a major market disruption, as we moved from a 0% to a 3% environment in one year. However, we have not seen such disruption in the Eurozone market, except for the collateral scarcity situation mentioned earlier. We have observed that the Eurozone issuers can still find investors, and the market has been resilient to rapid changes in monetary policy. Overall, the situation has been handled quite well, based on what we have seen so far.

Q: Will you be sticking to your target of approximately 10% of net medium- and long-term debt issuance this year being inflation-linked? Has the stickiness of inflation changed your thinking with regards to this?

A: The 10% target is not a fixed target but rather a soft one. It does not mean that we aim for exactly 10% every year. There were times when the demand for those bonds was higher and we were above 10%, and there were times when the demand was lower and we were below 10%. For instance, in 2020, we had the lowest share because of the unknown circumstances, no inflation, and less interest in hedging inflation risk.

The soft target is determined by two factors: an assessment of the market demand for our products and an evaluation of what it means for the state's asset-liability management. States are natural payers of inflation, but we also need to determine the amount beyond which it wouldn’t be the case. We calculate the soft target by considering both these elements and publish it every year in our financing program. So I can reiterate that for 2023, the soft target is 10%.

Q: Can you give an indication of how soft that target is? Are you currently on course for meeting it?

A: Currently, the amount of inflation-linked bonds we have issued is below 10%. However, it's important to note that we have plans to introduce two new inflation-linked bonds - one is confirmed and the other is dependent on market demand. When a new security is launched, the issuance amount is typically higher than in a regular auction. So, as we wait for the launch of these one or two linkers, we are still slightly below the 10% target.

Q: How would you assess demand for your planned linker issuances currently?

A: We have two inflation-linked securities that we may issue. The first is a 10-year bond that tracks Eurozone inflation. The second is a French inflation bond with a maturity of 15 to 20 years, depending on market demand. We evaluate market demand through our system of 15 primary dealers who trade the bonds daily, buying and selling. We gather our view of the market through them, as well as through direct contact with investors to determine whether the criteria for issuance will be met or not.

Q: And do you think environment is right, the current moment?

A: I'm not going to comment on the schedule of the possible issuance.

Q: With France having one of the lowest inflation rates in the Eurozone, do you notice a stronger or weaker demand for French inflation-linked bonds compared to the European inflation-linked ones you issue? Do diverging trends between the two play a role in your approach?

A: Our investor base is split between those interested in Eurozone inflation and those interested in domestic inflation. We are able to maintain liquid products on domestic inflation due to the size of this second group. Our policy is to be market neutral and issue products only when there is enough demand. The split between domestic and Eurozone inflation in our auctions reflects the relative demand for each product. Currently, there is slightly higher demand for domestic inflation relative to Eurozone inflation, compared to a year ago. This is due to dynamic structural factors for French inflation hedging, such as inflows into regulated saving product Livret A, which is linked to French inflation. As a result, the first four linker auctions of this year saw 35-36% of issuance on domestic inflation, which is above the previous years' levels. We have crossed the one third line during the first four months of 2023, issuance was significantly below this level in previous years.

Q: Could you maybe elaborate on other impacts that the Livret A has for you as a sovereign issuer?

A: Livret A account inflows need to be invested somewhere, and some of it is likely invested in inflation indexed as well as non-inflation-indexed products. Regulated savings are also meant to extend loans for social housing, sustainable projects, and more. However, due to the time it takes to originate and distribute loans, inflows first move to financial products before building their own portfolio. The main impact for us is that some inflows are invested in French government securities. In other countries, you might see direct investment from retail depositors in government products, whereas in France, this happens through the Livret A. As a result, this retail demand doesn't appear in statistics as retail demand, but as demand from banks.

Q: Investors seem worried about persistent inflation pressures in the Eurozone, with euro 5y5y inflation swaps trading at multi-year highs. Do you think we are seeing a de-anchoring of market inflation expectations? How does this impact your issuance plans?

A: There are two ways to analyse the current situation: either as a de-anchoring, which would be concerning for all issuers as it would lead to much higher nominal interest rates, or as the buildup of an inflation premium, which would not be surprising given the inflation shock experienced by investors in 2021 and 2022. Other factors may also be at play, such as pure demand and supply dynamics. While we have maintained our commitment to the inflation-linked market, there is likely more demand overall for these products than we are seeing on the supply side. Overall, I don't think de-anchoring is the main explanation. Instead, it's more likely a buildup of inflation premia along with supply and demand effects.

Q: You have already issued the first of your ten-year nominal bonds and now just have the last one to issue. Could you give an indication of which factors are playing a role in your thinking as to the timing of this new bond?

A: When it comes to auctioning new benchmarks, our decisions are based on two factors: whether the previous benchmark has achieved liquid benchmark status, and advice from primary dealers on whether the market is ready to receive a new bond. Our first ten-year bond for this year was issued in April, and the second one is not scheduled for the next month.

Q: Are there any thoughts of reviving the swap programme, should we see some noticeable steepening of the yield curve in 2023/2024?

A: The purpose of the programme was for the state to save the term premia that was present on our curve and on the swap market. Market participants can make their assumptions based on this purpose. When we launched the programme, there was a consensus that there was a significant term premium in ten-year rates. Those who were comfortable with more volatility on the interest rate by exposing themselves to the two-year rate and its volatility could benefit from an arbitrage. The question is whether we are currently in a similar environment as we were 20 years ago and whether we will be in the coming years. The central bank reduced the term premia and inverted it during QE. There was a very significant negative term premia in the curve. If we talk about the debt strategy put in place in 2001, it is not abandoned but just suspended. To restart this programme, we would need to have a significant term premia that the state could save by entering into those operations.

Q: I recently read an interview with you in Le Point, and saw you speak on BFMTV. AFT has also released a series of podcasts. Do you think public interest in sovereign debt has grown in France recently? Are you seeing more interest in AFT’s work from the wider public as a result?

A: We've seen increasing interest in debt, especially during the Covid crisis when there was a significant increase in debt issuance to support the economy. This has led to questions about how it's done and the associated risks. While this interest is not new, the pandemic has increased public curiosity about the topic. We've responded to this by increasing outreach and communication efforts, not just with financial media but also in other media channels, to help explain the complex nature of the work we do. For example, we issued a green linker bond last year, which can be difficult to understand without technical knowledge. We believe it's important to be transparent and provide access to technical information, but we also have a duty to make it understandable. This is why we've developed podcasts and tutorials to help explain complex concepts to the public. However, it's not always easy because bonds and debt products are technical in nature and can be more challenging to understand than stocks.