LONDON Hedge funds are restoring bets that French bond prices will fall, speculating the country's gamble on increasing public spending to boost economic growth will fail.
Funds have already been burnt on the trade. Last year, the European Central Bank's promise to buy government bonds to restore confidence in the euro zone sent yields on French 10-year bonds tumbling by more than a third.
But that is not putting some off from trying again.
With President Hollande's approval ratings at the lowest of any modern French leader and March jobless claims at an all-time high, some funds think the country's bond yields should trade closer to those of Italy and Spain than Germany.
"The most interesting bet to make in Europe is in France. I still feel in France that the risks are really underpriced," said Philippe Gougenheim, CEO of Swiss-based Gougenheim Investments, who has recently gone long German bunds and short French bonds using futures.
According to data group Markit, the volume of French bonds out on loan has risen 17 percent from an October low to more than $54 billion (35 billion pounds) last week. This can indicate short-selling - borrowing a security to sell it with the aim of buying it back at a lower price - although the bonds can also be borrowed by institutions wanting to hold sovereign debt as collateral.
While still some way short of spring 2012 levels, the trades are being closely watched as hedge funds are sometimes seen as harbingers of bigger market moves.
The volume of German bonds out on loan has fallen 0.4 percent since October, while in Spain it is down 2.7 percent. In Italy, another country that may be in hedge funds' sights, the amount is up 55 percent.
THE NEXT PROBLEM AREA?
Hedge fund interest in shorting France has ebbed and flowed over the past year as markets weigh up the success of the Socialist government's drive to boost growth by raising public spending, against European peers that have slashed theirs.
The recent signs have not augured well for the French way.
Economists polled by Reuters expect the French economy shrank 0.2 percent in the first quarter, compared with forecast growth of 0.3 percent in Germany. Meanwhile, France's budget deficit was 4.8 percent of GDP last year, whereas Germany had a small surplus.
Funds have also been offered a better entry point for the trade than last year, with French bond spreads over bunds down by one-quarter over the past six months, while the lower yield means funds have to pay out less now when they borrow the bonds.
Other managers shorting France include Pedro de Noronha, managing partner at Noster Capital, who last month went short French 10-year bonds and long on the German equivalent.
"France may well be the next problem area in the EU," he wrote in a note to clients.
"We believe that France's public finances are under pressure with a President who understands very little of economics ... Sooner or later, the market will re-price French bonds more in line with their southern counterparts."
Meanwhile, Patrick Armstrong, CIO at Armstrong Investment Managers, has held onto a short bet on 10-year French bonds and thinks yields could go to 4 percent. "It doesn't seem to be on the horizon, but credit concerns will come up again," he said.
And while smaller boutique managers have been quick to bet on further French economic decline, the potential to cash in on new problems has not gone unnoticed by larger hedge fund firms.
"I think it (France) is (a short). I've thought it for a long time," said a manager at a multi-billion-dollar hedge fund firm, who did not want to be named.