France, More Risky Than Italy, Emerges as the Problem Child of Europe’s Government Bond Market

[Financial News] Italy, once the "problem child" of the euro area debt crisis, has been regaining investor confidence on the back of fiscal discipline and political stability. As that happens, France is emerging as the new risk country in Europe’s bond market. The unusual move in which Italian government bond yields fell below France’s has even reversed how financial markets view the two countries.
The Financial Times reported on the 27th local time that France has overtaken Italy as the biggest concern for European bond investors.
For much of this summer, the yield on Italy’s 10-year government bonds traded below France’s. That is the opposite of what had been seen for years, when Italy paid far higher yields than France. Higher government bond yields mean investors demand greater compensation for lending money.
The turnaround is rooted in fiscal conditions. According to the European Central Bank (ECB), Italy’s debt-to-GDP ratio fell from 154% in 2020 to 139% this year. France, meanwhile, saw its ratio rise from 114% to 117% over the same period.
Italy has been posting a primary surplus, meaning government revenue excluding interest payments exceeds spending. France’s fiscal deficit, however, has widened to more than 5% of GDP. Italy’s deficit, which reached 8% in August 2022 when Prime Minister Giorgia Meloni took office, fell to just above 3% last year.
Adam S. Posen, president of the Peterson Institute for International Economics (PIIE), said, "Italy has now become the model student of the G7 bond market."
During the euro area debt crisis in the 2010s, Italy was grouped with Portugal, Ireland, Greece and Spain as one of the fiscally weak PIIGS countries. But contrary to market fears, the Meloni government has maintained strict fiscal discipline and political stability, which has changed perceptions.
France, by contrast, is facing both fiscal deterioration and political uncertainty. Ahead of the presidential election in April and May next year, there is speculation that far-left Jean-Luc Mélenchon and far-right Marine Le Pen could face each other in the runoff. In Europe’s bond market, such a matchup is seen as one of the worst-case scenarios because neither candidate is considered market-friendly.
Some investors have started cutting their holdings of French government bonds and shifting funds to Italy. Evelyn Gomezrieti, a rates strategist at Mizuho Bank, pointed to the reduction in exposure by Japanese investors, who have traditionally held large amounts of French bonds, and said, "France is the new Italy."
Market watchers also say France is exposed to three risks at once: slowing growth, worsening fiscal conditions and political instability. Rohan Khanna, head of European rates strategy at Barclays, said, "If you ask market participants where Europe’s weak link is, most would point to France," adding that the country is a "Perfect Storm" for bond investors.

[email protected] Kim Kyung-min Reporter