The spread between short- and long-term government bonds is widening, steepening the yield curve. Concerns about public debt sustainability in France and the US, along with Dutch pension fund reform, may lead to further bond price declines and higher yields. Fund managers prefer short and medium-term debt, as well as peripheral government bonds.
The Eurozone bond market is not expecting further interest rate cuts by the ECB in the final months of 2025, but fears of a French crisis damaging the economy and financial institutions could bring more volatility to fixed income. The Morningstar Eurozone Treasury Bond Index is up 0.41% since January, impacted by concerns about France’s public debt sustainability.
The steepening of the government bond yield curve reflects investors demanding a higher premium for holding long-term securities. Public spending increases to support defense and infrastructure in the eurozone may push markets to demand a higher risk premium, exacerbating the curve. France’s debt/GDP ratio has risen from 95% in 2015 to 110% currently.
During the pandemic, the yield curve was flat or inverted due to expansionary monetary policies. The yield of the 30-year German bund rose from 3.00% in May to 3.33% in September, with a spread of 1.33 percentage points over two-year bunds. A rising yield spread can indicate uncertainty about a debt instrument’s long-term sustainability.
Rating agencies are reassessing ratings for euro area countries, with France’s sovereign debt downgraded and Italy upgraded by Fitch. Approval difficulties for the French budget law could widen the government spread and affect the banking sector. Concerns about US public debt sustainability could lead to higher rates on longer maturities.
Dutch pension fund reform from 2028 shifts to a defined contribution model, reducing reliance on long-term government bonds. An estimated EUR125 billion worth of 30-year bonds may be sold by Dutch pension funds, putting pressure on yields. Despite France’s challenges, Italian bonds have shown resilience, with the spread to German bunds at a 15-year low.
Eurozone periphery countries like Italy, Spain, and Greece have transformed, showing stability and growth. Core-periphery distinctions are less pronounced, with narrow sovereign bond spreads. Fund managers are positioning for the fourth quarter by favoring bonds over cash, benefiting from the negative correlation between bonds and equities, and seeking protection with positive real yields. The yield curve has steepened, leading to increased attractiveness of bonds over cash. Fund managers are favoring short and medium-term debt, as well as peripheral government bonds. Alessandro Tentori of AXA Investment Managers predicts that duration risk may become more attractive relative to credit risk as the yield curve continues to steepen. Italy and Spain are viewed positively, while caution is advised for Germany due to potential bond issuance increases. Credit, particularly investment-grade credit, is seen as a good source of return with acceptable risk levels. Riskier assets should be closely monitored due to geopolitical and economic risks.
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The yield curve has steepened due to widening spread between short- and long-term government bonds amid concerns about public debt sustainability in France and the US, as well as Dutch pension fund reform. Fund managers favor short and medium term debt, along with peripheral government bonds.: Where to Invest in Q4