What’s up with European bonds

Move aside US Treasuries, it’s European bonds getting all the attention right now. 

You see, it turns out Japan offloaded $13B worth of German bonds back in April, even after Friedrich Merz looked set to restore Berlin’s political stability and fiscal sustainability.

Who cares?

One’s care-factor might depend on what drove Japan’s decision to sell:

• Does famously long-term Japan no longer see Germany as a good bet?
• Did Japan just want to free up some cash for emerging priorities back home?
• Or… might it have something to do with all those sizzling rumours that US trade negotiators are nudging governments to purchase US bonds, meaning Tokyo might’ve simply swapped bunds for bonds.

It also depends a little on how you view what’s happening in Italy, Spain, and Greece.

Long the EU’s fiscal bad boys, markets are now suggesting there’s not too much risk-difference between lending to these three versus their thrifty neighbours like Germany.

• Italian bond yields are now <1% higher than in Germany(versus a full 5.7% higher a decade ago)
• Spain has now pushed its borrowing costs below high-fallutin’ France, and
• Even Greece, once flailing under the frugal gaze of Angela Merkel, is now only facing borrowing costs a tad pricier than those confronting Paris. 

What’s going on?

As always with bonds, there are a few drivers in parallel, including…

• The European Central Bank’s rate cuts, which tend to have bigger impacts at the bloc’s periphery (more liquidity and confidence, lower risk perception)
• Those periphery capitals have also done a bang-up job of lowering their debt-to-GDP ratios lately, giving investors and lenders more confidence
• Giorgia Meloni seems to have cracked the code for political stability in Italy, and
• The EU’s big spending plans around recovery and security have encouraged fiscal discipline while enabling joint EU borrowing (something Berlin resisted for years).

Arguably, the common theme across each driver above is that investors and lenders are now detecting a moment of cohesionin Europe.

Sure, Brussels will still be Brussels, and leaders will still roll into town wielding their veto like a stick to periodically jam through the EU’s spokes. But in the big picture, there’s now consensus around how much to spend, how to spend it, and how to finance it (jointly).

So all that to say… maybe Japan’s decision to sell German bonds wasn’t about Germany.

Intrigue’s Take

If we’re now arguably seeing new levels of EU unity… why? It’s partly the cumulative result of all the shocks over the past couple of decades, like the debt crisis, Brexit, Covid, Russia’s aggression, and big shifts in US positions around security and trade.

Each new shock has variously inflamed divisions within and between EU members, but at the same time, it’s also forced Europe’s leaders to reassess their appetite for greater integration to weather each storm. EU critics long saw each crisis and EU response as proof of the bloc’s eventual decline. And sure, history might prove them right.

But these bond movements also hint that maybe the critics are wrong: perhaps the EU’s architects didn’t plant the seeds of the bloc’s own demise, but rather built in just enough flexibility for the kinds of financial engineering and political manoeuvring necessary not only to adapt to each new shock, but to evolve into a stronger bloc. Maybe.

Sound even smarter:

• US Treasury prices rallied and yields dropped yesterday (Wednesday) after cooler US inflation data eased investor worries about the Trump tariffs, while raising hopes for a Fed rate cut by September.

Overheard in the Intrigue chat:
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• “I remember when Macri won, Argentina was able to issue a 100 year bond in US$ in 2017 and how everyone was shocked (even us Argentines).” – C.G