The France-Italy unfold has flipped | USAEMALL.com

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Eurozone sovereign bonds — unlike US, UK, or Japanese bonds — are not issued by governments that can, pretty much, make up new stuff and call it money.

As such, yield differences between bonds of the same tenor carry some information as to the market’s expectations for the likelihood of default.

Bond pedants will object that they also contain information about liquidity preference, relative levels of domestic financial repression, and a bunch of other things. And sure.

But still, it’s sort of interesting — in a Friday afternoon sort of way — to see that France has started to trade at a spread over *checks notes* Italy.

We noticed two-year BTPs trading through two-year OATs back in May. But frankly, two-year bonds can be a bit weird. Two-year BTPS traded through OATs briefly at the end of 2023 and the beginning of 2024. We just assumed that this was another one of those times and didn’t give the matter much thought.

But this week the spread of five-year BTPS over five-year OATS has flipped from positive to negative:

This looks like it’s a bigger deal. As far as we can see, it’s been over 20 years since France traded through Italy at the five-year tenor point. And it’s fair maybe to call 2005 the ‘before times’ — when European sovereign borrowers were seen as much of a muchness and sovereign spreads were pretty much meh.

Looking out to 10 and 30 years, Italian bonds still offer higher yields than their French bond counterparts. But they are increasingly seen as much of a muchness:

Has Meloni wowed the market into understanding Italy to be now devoid of credit risk? Nope. This is all about investors becoming incrementally less willing to take French risk without being more generously compensated. We think looking at French and Italian spreads over five-year swaps tells this story most cleanly:

If anyone needs reminding of the human and economic costs that can follow when the bond market cuts a government’s credit line (and the central bank won’t step in) they could do worse than read MainFT’s spectacular Big Read today on How Greece came back from the brink.

But before we get too carried away with ideas about the market pricing in an incipient collapse of the Fifth Republic, let’s reflect that we’re still a long way from Eurozone crisis levels. And long may they stay that way.