Higher deficits pushing European government bond yields higher

Germany’s parliament recently passed a bill to increase infrastructure and defense spending in the wake of the Trump administration’s statements about Europe needing to step up military expenditures. Other European governments in France and Italy could follow suit. With potentially increased deficits and debt, major Eurozone countries’ bond yields have been increasing, which may present an opportunity given falling inflation rates.

Rising Eurozone yields: Major Eurozone countries’ 10-year government bond yields have increased since the end of the year as the countries, notably Germany, have sought to increase spending. The rise has been particularly pronounced since late February, including the yield on Germany’s bund increasing 37 basis points to 2.78%. The 10-year U.S. Treasury yield stood at 4.24%, down from 4.58% as of Dec. 31.

Budget deficits: These European countries were already running budget deficits before any new spending plans, according to data provided by the International Monetary Fund’s World Economic Outlook that published in October. The IMF projected Germany’s 2024 deficit at 2% of its gross domestic product, and 3% to 6% for Spain, Italy, and France.

Tame inflation expectations: Inflation has been dropping. The IMF forecasts Germany’s inflation rate fell to 2.5% in 2024 vs. 6% the previous year. Italy and France likely had large drops of 480 and 330 basis points, respectively, to 1.1% and 2.3%. Spain’s inflation rate came in at 2.9%, according to the IMF.

Pension fund holdings: Fixed income made up a significant portion of U.S. pension fund assets, according to responses to Pensions & Investments’ 2024 Top 1,000 survey of the largest plan sponsors. However, U.S. fixed income instruments made up the bulk, 21.6%, of total assets, and non-U.S. bonds were 2.2%. The portion in non-U.S. fixed-income markets has ranged from 1.3% to 3.3% since 2006.

Sources: Bloomberg, U.S. Department of the Treasury, International Monetary Fund, Pensions & Investments