Investors indicate that with France confronting a difficult budget negotiation next month and rising poll numbers for far-left and far-right parties ahead of next year's presidential election, France has dethroned Italy as the focal point of market worries over European debt sustainability. For years, Italy's benchmark 10-year government bond yield stood notably higher than France's, yet for much of this summer, Italy's yield has actually traded below France's, signaling that bond investors are demanding added risk compensation for holding French debt. (As bond prices climb, yields decline.)
Investors describe this reversal of a long-standing trend as representing a significant shift in how markets perceive and price the relative risks of the two nations. Rohan Khanna, head of European rates strategy at Barclays, noted: "If you ask market participants who Europe's weak link is, the vast majority would point to France. Italy has passed the baton to France." Khanna added that a convergence of growth risks, political risks, and fiscal risks amounts to a "perfect storm" for France from a bond investor's perspective.
More than a decade ago, during the eurozone debt crisis, Italy was among the "PIIGS" nations with outsized debt burdens, long regarded as Europe's riskiest borrower with one of the region's largest public debt loads. In contrast, France was historically viewed as the safer option. But as both nations push through arduous budget negotiations this autumn, followed by elections next year, investors are refocusing on France's deteriorating fiscal position, while mounting concerns emerge that market-unfriendly candidates could win the presidency. Italy, meanwhile, is pursuing fiscal austerity and enjoying a period of rare, extended political stability, drawing growing favor from global investors.
Adam Posen, president of the Peterson Institute for International Economics in Washington and a former rate-setter at the Bank of England, commented: "Italy is now the positive exemplar among G7 bond markets." European Central Bank data shows Italy's debt-to-GDP ratio has fallen from 154% in 2020 to 139% this year, whereas France's has risen from 114% to 117%. Italy has also achieved a primary fiscal surplus—meaning tax revenues exceed spending before interest payments—while France's deficit has widened to more than 5% of GDP.
Tomasz Wieladek, chief European macro strategist at T. Rowe Price, remarked: "In the past, the biggest risk in Europe was indeed Italy, and everyone was on edge about it... but now France's risk profile is rapidly converging with Italy's." He added that there are already signs of investors repositioning, trimming French bonds and adding Italian ones. In recent weeks, French bonds have come under pressure as the government unveils details of its budget plan, with the full draft proposal expected to be submitted to the National Assembly on September 30. French Finance Minister Roland Lescure stated this week that the goal is to keep the deficit as close to 5% of GDP as possible.
The minority government needs support from the Socialist Party to pass the budget, but the Socialists are likely to oppose cuts to social welfare spending. In both 2024 and 2025, France's government collapsed over budget standoffs. This year's budget was passed after Prime Minister Sébastien Lecornu made concessions, delaying pension reform until after 2027 in exchange for the votes needed to secure approval. Italian Prime Minister Giorgia Meloni and Finance Minister Giancarlo Giorgetti, who once sparked fears of fiscal profligacy and confrontation with the EU, have now earned plaudits from bond investors for their strict fiscal discipline. Italy's fiscal deficit has fallen from 8% in 2022, when they took office, to just above 3% last year.
Chris Jeffery, head of macro strategy at Legal & General, said his portfolio holds a lower allocation to French bonds than the benchmark, "with some funds shifted toward Italy." Jeffery noted: "With a presidential election looming, politicians are unlikely to proactively push through budget cuts." Analysts suggest other international investors are also recalibrating their views on both France and Italy. Evelyne Gomez-Lichti, multi-asset strategist at Mizuho, pointed out that Japanese investors, who have traditionally held large amounts of French debt, are scaling back their French bond allocations. "France is the new Italy," Gomez-Lichti said. Recent polls show a rising probability of far-left candidate Jean-Luc Mélenchon reaching a second-round runoff against far-right leader Marine Le Pen, a scenario Gomez-Lichti described as "the market's least desired outcome."
Filippo Taddei, senior European economist at Goldman Sachs, noted that foreign ownership of Italian sovereign debt has risen since March 2023, reflecting a return to normalcy in market standing for the country, which was viewed as a problem economy for years after the 2008 financial crisis. Taddei stated: "Capital is being reallocated across Europe, and Italy has become a recipient of inflows—something that would not have happened in the past." Italian bond yields fell below France's last year for the first time since the financial crisis, but a spike in oil prices following the US-Iran conflict quickly pushed them back above. Italy is especially sensitive to energy price rises, while France has higher domestic energy self-sufficiency. Yet even as oil breached $94 in August, French yields remained above Italian ones. A metric gauging France's long-term debt risk premium—the 15-year forward swap spread versus Germany's equivalent, which strips out short-term monetary policy expectations—has surged sharply in recent years.
Mike Riddell, fund manager at Fidelity International, said France's risk premium is "not far off levels seen during the eurozone debt crisis," adding that "the fiscal situation is a mess." Although Italy currently enjoys lower funding costs than France, markets continue to pressure Rome to stay on its austerity path. Goldman's Taddei remarked: "Markets have memories. Investors won't easily forgive Italy's history of fiscal profligacy." "To receive the same market treatment as France, Italy must run a much more cautious fiscal policy compared to both France and Germany."
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