Major Reversal! Political Stability and Fiscal Improvement Become Key Attractions as Bond Investors "Abandon France for Italy"

According to Zhitong Finance APP, as the market prepares for next year’s elections in Italy and France, an increasing number of bond investors are betting that Italy’s political climate will be calmer compared to France. In recent months, asset management companies Barings and Carmignac Gestion have been increasing their holdings of Italian bonds, joining other investors such as MFS International who are already bullish on Italian debt. These capital inflows are pushing Italian bond yields down below those of French bonds of comparable maturity — a reversal of the norm, as French bonds have traditionally been seen as safer but are now being traded at a higher risk premium demanded by investors.

French bonds are being priced with a premium due to increased political risks

Many investors are now steering clear of French bonds because France is set to begin budget negotiations next month, a process likely to become a political flashpoint and set the tone for next spring’s presidential election. Meanwhile, investors believe that the era of fiscal chaos and political turmoil in Italy is now part of history.

Italian Prime Minister Giorgia Meloni is seeking to win a second term. Barings portfolio manager Brian Mangwiro, who has been buying Italian bonds with maturities up to 10 years, stated: “This may be one of the longest-serving and most stable governments we have seen in Italy for a long time. We continue to see the risk of major political turmoil in Italy as quite low, and that is part of the reason why Italy is one of our biggest overweight positions.”

This sentiment marks a sharp turnaround in the bond market’s view of Italy since 2022. When Meloni first took office that year, Italian bonds were sold off aggressively. Now, with Italian bond yields lower than those of France, it reflects a structural shift in Europe’s bond market — a major reversal since the eurozone debt crisis.

In recent months, global bonds have generally been hit by concerns that rising oil prices will drive inflation higher, and eurozone bonds have been no exception. However, Italian bonds are emerging as a surprising safe haven in the region. This reflects market optimism regarding Meloni’s commitment to curbing Italy’s fiscal deficit — in contrast, given the growing popularity of populist politician Marine Le Pen, it may be much harder for the current French government to achieve similar goals.

It is reported that Meloni is considering calling the next general election several months ahead of the legal deadline at the end of 2027. However, the possibility of early elections does not seem to have deterred investors from continuing to buy Italian bonds.

Carmignac Gestion fixed income manager Marie-Anne Allier said: “Italy seems to be a country that at least offers political stability, and at least its debt-to-GDP ratio will decline. Compared with other European countries — except Spain, and especially compared with France and Germany — these are two major advantages.” Reportedly, Marie-Anne Allier has been buying Italian bonds since the beginning of the year, while shorting French bonds.

Natixis SA rates trader Youness Boukakiou pointed out that momentum in Italian bonds has been building over the past few months. He notes that buying 3- to 10-year Italian bonds has become one of the most popular trades this summer. Meanwhile, he added that many market participants have been avoiding French bonds.

Youness Boukakiou stated: “If you want to buy assets in the European sovereign bond space that offer yield, you have two options now: France or Italy. And at this stage, the outlook for Italy looks better.”

Furthermore, according to ABN Amro Bank senior rates strategist Larissa de Barros Fritz, another favorable factor for Italy is that only 9% of its sovereign bonds are held by non-eurozone investors, compared to 26% for France. Regional investors are more likely to withstand event risks and hold bonds to maturity. At the same time, 14% of Italian government debt is held by Italian households, whereas the proportion in France is zero. Larissa de Barros Fritz noted that this fact “provides support in the current environment.”

Annalisa Piazza at MFS International remains overweight Italian bonds. If political posturing leads to a sell-off in Italian debt, which she considers unwarranted, she would look to increase her positions further. She said that if there is significant market volatility and “the market panics because of it, I would buy.”