According to their debt servicing costs, Cyprus, Spain and Croatia appear to be less risky investments in the bond market than the second largest European economy, France.
The Eurozone government bond market has been undergoing a transformation over the past year.
“Broadly speaking, there has been a big drop in yields across the eurozone,” Frank Gil, managing director and specialist at S&P Global Ratings told Euronews Business, adding that “the big exception is France.”
Some of the biggest surprises came from the bond markets of the bloc’s so-called peripheral countries, which struggled with unsustainable debts in the immediate aftermath of the 2008 financial crisis, including Portugal, Spain and Greece. Today, most of them have to pay less to service their debts than longtime favorites France.
French bond yields beat Spain’s as investors ponder budget woes
One reason is that these countries have put their debt on a sustainable path, with low inflation and high growth.
“Some of these countries with large tourism sectors that have very high growth rates, very strong labor markets and have budget surpluses, including Portugal, Greece, even smaller economies like Cyprus,” Gil said. “They are paying off the debt. Therefore, the absolute amount of debt in the market is decreasing. And I think that explains why Greece’s 10-year yield is down 0.5% from last year.”
Gil expects this trend to continue in 2025.
“I think if these countries continue to run budget surpluses, meaning their overall debt levels are falling and falling very quickly relative to GDP because GDP is growing rapidly, then I think you will continue to see a convergence of their yields towards German yields,” he said. Gil.
How did France lose some of its investors’ trust?
Europe’s second-largest economy has attracted unwanted attention again this year, with turbulent political turmoil, the latest chapter of which saw the country end the year without a valid new budget for 2025.
For now, a special law allows public services to pay salaries and collect taxes, otherwise, the government must adhere to the 2024 budget ceiling until a new budget is approved.
Accordingly, investors expect the French deficit to remain at the same level as in 2024, slightly more than 6% of GDP. To finance this, the country will have to continue to borrow from the market, further increasing its debt, which already stands at 112% of GDP.
In the short term, uncertainty caused by the lack of clear fiscal policy and plans to put debt on a sustainable path may not allow the currently elevated yields to decline quickly in 2025.
“I definitely think there could be some volatility in the French OAT market [francuske obveznice se zovu OATs što je skraćenica za Obligations Assimilables du Tresor] next year, depending on what the 2025 budget will look like, assuming that the budget will be finalized early next year,” Gil said.
He added that the country has a very significant deficit. “The debt-to-GDP path, as we plan, will continue to rise between now and 2027, without much significant adjustment.”
However, yields on France’s 10-year bonds rose to 3.05% after credit rating agency Moody’s downgraded the country’s debt on December 14 and have risen steadily since then, while “France’s real cost of borrowing has not changed that much since December of last year,” Gil said, adding that “last year in December, their borrowing costs were around 2.75%, 2.8% on a ten-year maturity.”
The majority of French debt is held by non-residents
The cost of servicing French debt has also been fueled by investor concerns about who holds it. “Just over 50% of French debt is held by non-residents,” Gill said, adding that “there may be concern that non-residents could reduce their holdings of French bonds, which would mean that local banks and domestic lenders would have to absorb more supply, which would probably led to an increase in prices”.
Meanwhile, Germany is also going through political turmoil with increased uncertainty as the government recently suffered a vote of no confidence and early elections will be held on February 23, 2025, Investor me reports. Meanwhile, the country’s economy is shrinking.
Still, German 10-year yields were sitting comfortably around 2.36% at the time of writing.
“I don’t think there are significant credit risks for Germany,” assured Gil. “We would argue that German debt to GDP is actually quite modest. They have a very significant fiscal space and the economy as a whole realizes huge surplus savings.” He also expects Germany to loosen fiscal policy to stimulate growth.
“I think the market is looking at the policy of the incoming government. So they will focus on the election. What do they propose in terms of budget policy and budget incentives? Will there be any special industrial policies that require public subsidies, anything that implies a larger supply of debt in two, three or four years?” he asked.
France and Germany are very rich economies that generate huge domestic savings.
“France is also a very liquid system. Banks are extremely liquid. Banks don’t really have much exposure to the sovereign. So I think that while there are definitely medium-term challenges, fiscal challenges, political challenges and growth challenges in both Germany and France, their ability to self-finance is extremely comfortable,” Gil said.
