European bond markets are staggering into the fourth quarter, having briefly reached the highest 10-year yields for a decade. But with no apparent home-grown trigger, this yield surge is more likely the result of ill-winds coming from across the Atlantic and battering everything in their path.
While Italy and France have posted some concerning budget deficit estimates, there is nothing novel in Europe’s economic backdrop. What’s different now is the relentless climb of US Treasury yields and the strength of the greenback. The dollar index has gained 6% versus a basket of world currencies since mid-July, with 10-year US yields rising 75 basis points over the same time. Europe is powerless to resist these forces, especially when crude oil is uncomfortably close to $100. Despite some promising inflation data, with core prices increasing at the lowest for a year, there are fewer compelling reasons to be invested in euro or sterling assets when the dollar is this strong.
Italian yields matched the rise of US Treasuries through the summer, though French and German equivalents have risen a more measured 50 basis points. There is understandable investor concern that Italy’s fiscal deficit targets have been raised at the same time as growth estimates were lowered. These are still too optimistic.
But what matters in the European Union is whether it is within the limits of political acceptability. Italian Prime Minister Giorgia Meloni is certainly testing those boundaries in Brussels, but so far there is no real sign she’s overstepped them in an uncontrollable manner. The lesson of the euro crisis is that sticking together and working through the problems is the only solution.
France, which has an even larger debt pile now than Italy, is also going to breach EU fiscal rules this year and in 2024. Nonetheless, budget deficits in the EU are coming down from the extreme levels of the pandemic — just at a glacial pace. The 10-year yield premium demanded for Italian debt over benchmark Germany has expanded since July by 30 basis points to the current 190 basis points but that only matches levels earlier this year. Some poorly received auctions may have worsened sentiment and exacerbated the yield fallout in Europe — but for the real culprit look Stateside.