Briefly substituted markets in the long-term sphere have seen an upside-down flip, with conventional norms seemingly disregarded.
Back in the times of the global financial crisis, the southern Europe trio of Spain, Italy, and Greece was in hot water with the bankers, thanks to their lack of financial discipline, massive debts, and bloated budget deficits. Things were the worst in Greece, which almost fell out of the eurozone due to a severe financial crisis. But fast forward to today, even amidst the chaotic global trade events, sky-high volatility, and uncertainty, the situation in these so-called poor-southerly economies is dramatically better than that of the wealthy, prosperous north. Bond markets in Spain, Italy, and Greece are on a roll with government bond yields plummeting, something unimaginable not too long ago.
The scenario has nearly flipped around: countries once known for their poor financial discipline, bloated bureaucracy, and excessive, unjustified spending are now almost models of high discipline and cost-cutting. The roles have reversed: it's Washington, Berlin, and Tokyo that now seem like the spendthrifts, while Madrid, Rome, and Athens are setting examples in fiscal prudence and efficiency.
Bloomberg reports an astonishing shift, with the gap between what investors demand, for example, Italian government bonds instead of the previously benchmark German bonds, dropping below 1%, down from 5.7% a decade ago.
As per Patrick Barbe, a senior portfolio manager at American investment company Neuberger Berman, "the overall environment is greatly favorable for the periphery." They've surpassed fiscal expectations and have a higher growth rate than most developed countries."
While the premium for returns on Italian government bonds is predicted to hit a 15-year low, the yield on 10-year French government bonds now overshadows Spanish government bonds and is only 3 basis points lower than Greek government bonds.
The shift has been particularly dramatic in Italy. For years, the third-largest economy in the European Union was associated with chaotic politics, anemic economic growth, extravagant government spending, and volatile government bonds. Today, it's hard to believe that Italy is being pointed to as an example of how to manage finances in turbulent times.
The transformation is evident in the evolution of the risk premium for borrowing in Rome versus Berlin. Currently, it stands at 0.91%, a stark contrast to 2011 when it soared so high that the Italian government was forced to resign.
This shift helped Italy attract record foreign investments last year. However, on the German bond market, the picture is quite different. In April, Japanese investors made their largest exodus from the market in a decade, according to the Ministry of Finance of Japan.
Barbe and his team bought a large amount of Italian government bonds (BTP) during the April market chaos triggered by the introduction of American tariffs. They are betting that the difference in yields between Italian and German government bonds will decrease to 0.8% by the end of this year, while Barclays Plc expects it to drop to 0.7%.
"Honestly, this is quite a surprise," admits Patrick Barbe. "Of course, there are many questions surrounding American Treasuries, but VTR has never failed to surprise the markets before."
By May, the returns on American 30-year government bonds surpassed 5% for the first time since 2023, while the returns on 30-year Italian government bonds dropped by 50 basis points to 4.3% last month.
It's no wonder that as the United States lost its last "AAA" credit rating, Italy and Greece, who have managed to bring their spending and budget deficits under control, saw their credit ratings rise by a notch this year in S&P Global Ratings, with Italy now rated at BB+, four steps above "junk," and Greece at BB. In contrast, Germany's bond market situation may worsen in the coming years after Friedrich Merz, who abolished the debt brake and plans to spend around three trillion euros, came into power.
Of course, the road to recovery for the resurrected southern Europe is not without its pitfalls. Countries like these still carry some of the largest debts on the continent, and the surge in borrowing in the USA and Germany could continue to push interest rates higher. Despite the decline in risk premiums for peripheral countries, they will still end up spending more due to higher interest rates, which could worsen their fiscal positions.
The shift in financial markets has resulted in countries once criticized for poor financial management, like Italy and Greece, now positioned as models of fiscal prudence and efficiency. In contrast, wealthy nations such as the United States and Germany are being viewed as spendthrift, with higher risk premiums for borrowing.
Barclays Plc expects the difference in yields between Italian and German government bonds to decrease to 0.7% by the end of this year, indicating a continued favorable environment for the periphery, as Patrick Barbe, a senior portfolio manager at Neuberger Berman, predicts.
