In just over two weeks, French voters will decide whether the dream of European monetary union lives or dies. Yesterday, bargain hunters in European bond markets decided to bet that it would survive.
That bet sent the prices of bonds denominated in European currency units, known as ECUs, up sharply for the first time in months. That market, into which investors were piling as recently as this spring, had almost collapsed.
Yesterday's rapid price increase drove the yield on the Paribas 10-year ECU bond index down to 9.65 percent from 9.85 percent Tuesday, according to Deutsche Bank.
By contrast, such bonds yielded less than 8.5 percent earlier this year. The yield remains well above where it theoretically should be, based on rates on bonds in the various European currencies that make up the ECU.
The rally yesterday surprised many market watchers and appeared to indicate that some traders were betting that French voters would support the Maastricht treaty on European monetary union in a referendum Sept. 20.
Last night, President Francois Mitterrand of France and an opposition member of Parliament who opposes the treaty staged a televised debate. Polls have indicated that the vote will be close, but if the measure passes, it seems likely that ECU bond prices will rally sharply.
Moreover, the market took heart from Britain's announcement yesterday that it would borrow the equivalent of 10 billion ECUs, or about $14 billion, in foreign currencies, which it will sell to bolster the pound.
Britain's decision to announce the amount in ECUs, rather than pounds or dollars, was viewed as "designed to indicate their commitment to Europe," said Gordon Johns, a managing director of Kemper Investment Management in London.
The recent saga of the ECU bond market -- rapid growth and excessive enthusiasm that sent prices up to unreasonably high levels earlier this year, followed by a rush to exit when sentiment turned negative -- has provided an example of just how ephemeral the notion of market liquidity can be. Liquidity was plentiful before early June, when no one wanted to sell. Then, when few wanted to buy, liquidity vanished.
The ECU is a basket of European currencies, and under the Maastricht agreement on European monetary union, it is scheduled to evolve into the single European currency. Investment banks eagerly embraced ECUs, and the issuance of bonds denominated in the units grew rapidly, from about 10 billion ECUs in 1988 to 28 billion ECUs last year. So far this year, almost 20 billion in ECU bonds have been sold.
"We've had fairly exponential growth," said Bob Tyley, the head of bond analysis for Paribas Capital Markets in London.
Since the ECU is made up of a basket of the 12 currencies of European Community countries, it is possible to calculate the approximate fair interest rate on ECU bonds, based on the rates of bonds in the 12 currencies.
Earlier this year, ECU bonds were trading at unreasonably high prices, yielding about two-thirds of a percentage point less than a theoretical basket of bonds in the 12 currencies.
"It was easier and more liquid to trade the ECU bond," said Hung Tran, a managing director of Deutsche Bank Research in Frankfurt, explaining the premium. "There was a strong expectation that by 1997 or 1999, there would be a single European currency, and yields would come down significantly."
Then came Denmark's vote in early June against ratification of the Maastricht treaty, followed by France's decision to submit ratification to voters, rather than to Parliament, where approval would have been certain.
Maastricht probably can be preserved without the Danes, but not without the French.