US, France lose ground as Germany emerges as bond market's safe haven

The US 10-year Treasury yield has surged to its highest level in two decades, renewing doubts about the country's fiscal credibility. France, which faces a debt burden comparable to that of the United States and deepening political fractures, has also seen its yields climb sharply. As investors dump the bonds of fiscally strained governments and rotate into safer alternatives such as German debt, preferences across European bond markets are diverging in increasingly stark ways.

According to the Financial Times on Wednesday (local time), the yield on the 10-year US Treasury note — the benchmark borrowing cost for the world's largest economy — climbed as high as 5.36% during a volatile morning session. It pulled back to around 5.288% after results of a $39 billion auction showed strong demand. That left the yield roughly 0.03 percentage points above the previous session's close.

The 30-year Treasury yield also touched 5.73% intraday before settling near 5.67%. Bond prices and yields move inversely: when prices fall, yields rise, and when prices rise, yields fall.

The strong auction demand helped prevent an even sharper rise in US yields. Kristina Hooper, chief global macro strategist at Man Group, said there had been considerable concern heading into the auction that demand might be weak. "It is natural that strong demand influenced the market," she said. "It was something of a relief rally."

Even so, the broader global bond market remains on edge as US yields hover at elevated levels. In Europe, the selloff has prompted investors to scrutinize the fiscal health of individual countries far more rigorously than before.

France has emerged as Europe's counterpart to the United States in this regard. The yield on France's 10-year government bond briefly rose to 4.93%, approaching the highest level since 2002 recorded earlier this month. The Financial Times said fears that France — the eurozone's second-largest economy — could face a full-blown debt crisis are fueling the selling pressure.

The spread between French and German 10-year yields widened to around 160 basis points (1 basis point = 0.01 percentage point) last week, the widest gap since 2012.

Italy and the United Kingdom, which have historically struggled to attract investors, held up relatively well in the latest bout of market turbulence, though analysts say both remain vulnerable. UK gilt yields were not spared from the volatility: the 10-year gilt yield rose 7 basis points to 5.447%, while the 30-year yield briefly climbed 13 basis points to 6.04% — its highest in 28 years — before retreating to just below 6%.

Germany, by contrast, is reasserting itself as Europe's preeminent safe haven. The 10-year German Bund yield fell 17 basis points last week, a sharp contrast to the 13-basis-point rise in French yields over the same period, as investors piled into German debt in search of safety.

Concerns had been raised that Germany's safe-haven status could erode as the country ramps up spending on infrastructure and defense, but Reuters said those fears now appear to have been overblown.

Sumitomo Mitsui DS Asset Management of Japan said it had recently sold some French government bonds and bought German and Japanese debt, describing the move into German bonds as a "flight to quality."

Other European countries with low debt levels also saw their bonds rally last week. Dutch yields fell 11 basis points, Swiss yields dropped 12 basis points, and Swedish yields declined 14 basis points.

Akshay Singhal, head of global short-rate trading at Citi, said the central question is whether a government has a credible fiscal policy. "Unfortunately, that is in short supply globally right now, and that is what is driving bond markets," he said. Hooper echoed that view, saying the bond vigilantes have arrived in force. "They are punishing countries deemed to lack fiscal discipline," she said. "You can see that clearly in European government bond yields over the past week."