Italy, Greece and Spain emerge as winners in bond market anxiety

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Italian, Spanish and Greek sovereign bonds have emerged as the unlikely winners from this year’s bond market ructions, mounting a “relentless” rally that has narrowed the gap with Germany’s benchmark borrowing costs to nearly the smallest in more than a decade.

Bond fund managers said the turnaround from the Eurozone debt crisis, when the countries endured soaring borrowing costs, was due to stronger than expected growth and increased sharing of debt burdens by the bloc’s members.

Italy now pays only 0.9 percentage points more than Germany in 10-year borrowing costs, close to the lowest spread in a decade and a half. Spain is borrowing at a cheaper cost than France, the euro area’s second-biggest economy, with a spread of less than 0.6 percentage points.

A rise in German bond yields, as investors anticipate Chancellor Friedrich Merz’s historic €1tn spending splurge on defence and infrastructure, have also helped to push down spreads.

By contrast, during the Eurozone crisis spreads in the so-called “periphery” ballooned amid concerns over unsustainable debt and potential break-up of the currency bloc.

“The main reason to have credit spreads is [to reflect the risk of] default or break-up. If anything, that has gone down,” said Nicola Mai, a sovereign credit analyst at Pimco. He predicted that the convergence in sovereign bond yields “is going to last”.

In Greece, the country whose debt woes triggered the regional crisis and resulted in a series of sovereign bailouts, spreads have fallen to 0.7 percentage points.

“The rally has been relentless,” said Fraser Lundie, global head of fixed income at Aviva Investors.

Investors have piled into southern European bonds despite the broader concern in global markets about heavy public borrowing that has driven up yields in big economies including the US, the UK and France.

Tighter spreads also reflect a longer-term strengthening in southern Europe’s public finances, as services-dependent economies prosper, helped by a post-Covid tourism boom.

Spain’s growth outpaced its larger Eurozone peers last year. Italy’s government under Giorgia Meloni has proven more fiscally cautious and stable than investors had anticipated. And Greece is enjoying a years-long recovery from the debt crisis that saw its credit rating lifted to investment grade in 2023.

Investors argue that common EU debt issued during the pandemic, and the potential for further integration, has supported the case for a convergence of borrowing costs.

Some EU leaders have touted common debt as a way to help fund the defence spending pledges, which would tie nations even more closely together in the market’s view, although other nations have opposed such a step.

A shift higher in yields since the Covid-era stimulus has also drawn in buyers for southern European governments’ debt at a time when Donald Trump’s erratic policies have led investors to become wary of US markets, according to fund managers.

“The higher bond yield environment is finding new demand [for bonds in the Eurozone periphery] . . . particularly when US Treasuries, German Bunds and UK gilts are proving volatile with concerns around growing supply in ‘core’ bond markets,” said Nick Hayes, head of fixed income allocation at Axa Investment Managers.

But some investors caution that high debt levels in southern Europe mean that concerns about such countries’ bonds could eventually resurface. Debt to GDP remains close to or more than 100 per cent of GDP in Italy, Greece and Spain.

Gordon Shannon, a fund manager at TwentyFour Asset Management, said investors were “missing the wood for the trees in thinking the place to ride out an increasing focus on fiscal weakness is the most indebted governments in Europe”.

Additional reporting by Barney Jopson. Visualisation by Ray Douglas