INVESTORS INTERESTED in euro-denominated government bonds face some peculiar challenges. For starters, they have 21 euro-zone countries to choose from, in addition to the EU’s own debt. Long holidays, including from trading desks, typically mean choppy markets during the summer. And for mysterious reasons, yields on ten-year German bunds, the bloc’s benchmark, tend to rise by 0.15 percentage points after August.
This year they started early, and not just in Germany. In recent weeks global bond markets have been febrile
INVESTORS INTERESTED in euro-denominated government bonds face some peculiar challenges. For starters, they have 21 euro-zone countries to choose from, in addition to the EU’s own debt. Long holidays, including from trading desks, typically mean choppy markets during the summer. And for mysterious reasons, yields on ten-year German bunds, the bloc’s benchmark, tend to rise by 0.15 percentage points after August.
This year they started early, and not just in Germany. In recent weeks global bond markets have been febrile (see chart 1). Yields have jumped just about everywhere as investors have sold off government debt (whose price falls as yields rise), spooked by rising inflation risks, uncertainty about economic growth and zero appetite for belt-tightening almost anywhere. On September 1st yields on Japan’s ten-year bonds hit 3% for the first time in 30 years. American 30-year Treasuries are not far off their 19-year high of 5.31% reached in mid-August. Equivalent British gilts, which now offer a 5.9% return, have not been this cheap since 1998.
European yields are not quite there yet. Ten- and thirty-year bunds still yield considerably less than at the last peak in 2008. Similar French bonds are no higher than they were back then. Nevertheless, European government issuers face peculiar challenges of their own.
Inflation is problem one. In contrast to America, where rising prices chiefly reflect strong domestic demand, the culprit in Europe is on the supply side, and out of policymakers’ control: the energy shock from the Iran war. Markets expect the European Central Bank (ECB) to raise its benchmark interest rate to 2.9% by mid-2027, up from 2% before America and Israel attacked Iran in late February. Moreover, when inflation risk is high and stems from a supply shock, investors demand extra compensation for holding longer-term securities. In part, that is because of the additional yield investors demand to compensate them for inflationary uncertainty. It is also because in a supply shock, the prices of bonds and stocks tend to sell off together rather than move in opposite directions, which makes debt a less attractive way to diversify a portfolio.
Europe’s second challenge is fiscal. Germany’s newfound love for debt-funded investment and persistent French profligacy have pushed interest rates up since 2025. This in turn has raised debt-servicing costs. In 2028 France will spend 6% of government revenue to redeem coupons, compared with 3% in 2019, estimates Fitch, a credit-rating agency. For Italy this will climb from 7% to 8.8% in the same period.
Because European taxes are much higher than in America as a share of GDP, raising them further to fill the fiscal gap is particularly hard. Cutting spending is politically unpalatable, especially with populist insurgents on the rise across the continent.
The third problem is that part of the rise in yields, aside from inflation, is driven by growth and investment outside Europe, which is sucking up capital. America’s economy is motoring along, helped by big investments in artificial-intelligence infrastructure. The tech giants leading the charge are projected to spend over $5trn on AI data centres between 2025 and 2030. Such spending in Europe is tiny by comparison. Despite declining profits stemming partly from underinvestment, European businesses are net savers (see chart 2).
Yet even though European firms are on the sidelines of the AI race, European bond-issuers are nevertheless caught up in it. That is because the American tech titans are selling their own long-dated bonds to fund their splurge—to the tune of $250bn this year and $400bn in 2027, reckons Goldman Sachs, a bank. These corporate issuers are as creditworthy as governments, and thus compete with them for investors’ money. They are responsible for almost a tenth of euro-denominated corporate-bond issuance this year, according to the ECB.
More debt globally means more supply of long-term bonds, and thus more “duration risk” (how much bonds change in price in response to a change in interest rates) for investors to absorb. In Europe the supply of bonds is also higher because the ECB is running down its holdings, to the tune of €1.2trn since 2022 and counting.
At the same time, demand from big buyers of long-term government bonds is softening. Pension funds which bought tonnes to fund defined-benefit retirement schemes are switching to defined-contribution plans that try to boost returns with riskier assets like stocks. Investors stepping into the government-bond market, such as hedge funds, drive a harder bargain.
“We are in a new global macro regime,” sums up Freya Beamish of TS Lombard, a research firm. In other words, don’t expect yields to come down in the foreseeable future. Borrowers across the continent better get used to it.
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