Germany "spares no effort" to raise the cost of the European bond market, with Italy and France likely to be the biggest losers

Germany's historic shift towards "doing whatever it takes" is driving bond yields in Eurozone countries to multi-year highs.

Since Germany announced its unprecedented fiscal expansion plan, the yield on 10-year German government bonds briefly approached 3%, reaching a new high since the global bond sell-off in 2023, pushing borrowing costs higher for other European countries.

This month, the yield on French 10-year government bonds rose above 3.6%, marking the highest level in over a decade, even surpassing the levels seen during last year's political crisis peak.

The yield in Italy reached 4%, the first time since July of last year.

Sören Radde, head of European economic research at hedge fund Point72, warned:

“The rise in yields may weaken the fiscal space for countries outside Germany to increase defense spending, particularly in France and Italy.”

Point72's simulations show that considering higher defense spending and yields, without cutting other expenditures or boosting growth, Italy's debt-to-GDP ratio could rise to 153% by 2030, while France's could rise to 122%, compared to current ratios of approximately 140% and 115%, respectively.

Debt Risks Have Not Fully Erupted

Reports indicate that currently, the yield spreads between Eurozone countries and Germany (i.e., the additional borrowing costs relative to Germany) remain relatively stable, suggesting that the market is not overly concerned about the impact of higher borrowing costs on governments with weaker fiscal conditions.

Meanwhile, the euro has strengthened, highlighting market optimism about economic growth prospects.

However, David Zahn, head of European fixed income at Franklin Templeton, warned:

“I think the yield spreads will also start to widen, as the system bears greater pressure. Countries that already have high debt-to-GDP ratios and high yields… will find it harder to borrow.”

Connor Fitzgerald, a portfolio manager at U.S. asset management firm Wellington Management, stated that the result may be an increase in the disparity of borrowing costs between different countries in the Eurozone, as their fiscal conditions will be scrutinized more closely.

Fitzgerald believes:

“The fundamentals of each country will become more important, and there should be a ‘general decoupling’ among borrowing countries.”

Germany's Increased Issuance of Government Bonds May Present Certain Opportunities

However, there are also views that European bond yields have always been lower than the global level, and Germany's aggressive borrowing behavior "has corrected this imbalance to some extent."

Market data shows that German bond yields have exceeded the equivalent maturity euro interest rate swaps for the first time in history, reflecting investors' expectations for a larger bond issuance.

Simon Dangoor, Head of Fixed Income Macro Strategy at Goldman Sachs Asset Management, stated:

"There is certainly no lack of funds to finance these (additional German expenditures). German households have substantial savings that can be used to fund this without weakening demand for other eurozone bond markets."

Some investors believe that the increased liquidity of German bonds may enhance eurozone policymakers' efforts to position the euro as a competitor to the dollar as a reserve currency.

Dangoor stated:

"(From the additional German bond issuance) you can create a useful eurozone AAA-rated reserve asset."