The shift is reshaping the hierarchy of European sovereign bonds. France has emerged as the main focus of selling pressure amid concerns over its large budget deficit and political uncertainty, while Italy remains vulnerable to contagion. Britain and Spain have so far avoided the worst of the market turmoil, while debt from Germany, the Netherlands, Switzerland and Sweden has benefited from demand for safer assets.
France at the centre of the selloff
France has been at the heart of the recent bond-market turbulence, with investors increasingly concerned about its fiscal position and the political uncertainty surrounding the 2027 presidential election.The country's 10-year bond yield rose about 70 basis points in September to its highest level since 2002, raising the government's borrowing costs and complicating efforts to reduce the deficit.
France acknowledged in September that its budget deficit would exceed its 5% target. Although the government has announced spending cuts and other fiscal measures, investors remain sceptical about their implementation.
France is also planning to issue a record 340 billion euros of bonds in 2027 to finance government spending and refinance debt accumulated during the COVID-19 pandemic.
The spread between French and German 10-year borrowing costs, closely watched as a measure of France's risk premium, reached almost 160 basis points last week, its highest since 2012. Although the gap narrowed earlier this week, it has started widening again, suggesting investors remain cautious.
The euro has also come under pressure from the bond selloff, with some analysts seeing a potential decline towards $1.10.
Despite the deterioration, the current divergence between German yields and those of other euro zone countries remains well below the extremes recorded during the European debt crisis, when Italy's spread exceeded 500 basis points and Greece's surged above 3,000 basis points, Reuters reported.
Italy faces contagion risk
Italy is also coming under scrutiny as investors assess whether concerns over France could spread to other highly indebted European economies.The spread between Italian and German 10-year bond yields widened to about 130 basis points last week, compared with around 80 basis points a month earlier.
Italy's fiscal outlook has added to investor concerns. The Italian government said last week that its deficit was expected to rise significantly above the European Union's 3% limit, while its debt-to-GDP ratio is not expected to begin declining until 2028.
Italy's debt-to-GDP ratio currently stands at around 138.6% and is expected to overtake Greece's this year to become the highest in the European Union.
Political uncertainty is another factor investors are monitoring, with Italy scheduled to hold an election next year.
Elsewhere, Greece's yield spread over Germany has climbed to its highest level in two years, while Belgium's 10-year borrowing cost rose 49 basis points in September, one of the largest increases among European sovereign markets after France.
Britain and Spain avoid the worst
Britain's gilt market has also faced higher yields, although the increase has been significantly smaller than in France.The 10-year gilt yield climbed 36 basis points in September to around 5.43%, roughly half the increase recorded in French 10-year yields.
Investors remain alert to Britain's upcoming October budget, with markets looking for signs of fiscal discipline as well as measures aimed at improving long-term economic growth. The turmoil in the gilt market following Britain's 2022 mini-budget remains a reminder of how quickly concerns over public finances can trigger a sharp repricing of government debt.
Spain, meanwhile, has benefited from stronger economic growth and a substantial improvement in investor sentiment toward its bonds.
Spain's 10-year yield is now around 75 basis points below France's, a dramatic reversal from the euro zone debt crisis in 2012, when Spanish yields were roughly 500 basis points above French borrowing costs.
Investors are closely watching whether concerns surrounding France spread into other European sovereign markets, particularly countries such as Spain and Portugal that currently have stronger fiscal and economic fundamentals, Reuters reported.
Germany returns as safe haven
Germany has regained its position as Europe's preferred safe-haven bond market after investors' earlier concerns about higher German spending on infrastructure and defence proved less disruptive than feared.The German 10-year Bund yield fell 17 basis points last week even as French yields rose, highlighting the flight towards perceived safety.
Some international investors have recently reduced their exposure to French government bonds in favour of German and Japanese debt, reflecting renewed demand for higher-quality sovereign assets.
Other European countries with relatively low debt levels have also benefited from the shift. Dutch 10-year yields fell 11 basis points last week, while Swiss and Swedish yields declined by 12 and 14 basis points, respectively.
The moves underline how quickly investor preferences can change when concerns over fiscal sustainability intensify. Rather than selling European bonds indiscriminately, investors are increasingly differentiating between countries based on debt levels, fiscal discipline, political stability and economic prospects, Reuters reported.
(Disclaimer: This article is based on inputs from agencies. These do not represent the views of The Economic Times)
Add as a Reliable and Trusted News Source Add Now!
(You can now subscribe to our ETMarkets WhatsApp channel)