Key Takeaways
Eurozone sovereign debt markets have entered a regime in which idiosyncratic country differences are the main determinant of each country’s bond yield.
This is in contrast to previous regimes. During the convergence period they were treated as perfect substitutes, and later, during the crisis one, it was a country’s “core” or “peripheral” status that largely determined market performance.
The recent widening of French government debt illustrates these dynamics. The lack of contagion to other European debt markets shows that the market was not pricing denomination or credit risk. Instead, the expectation of higher future debt supply meant prices had to fall to clear the market.
- These dynamics also reflect the fact that the distinction between “core” and “periphery” has become less important. Our analysis suggests that France is better thought of as peripheral, but that is not what is driving its bond market.
The current regime probably represents a stable equilibrium, but future regime shifts cannot be ruled out. Full capital markets union would probably see a return to convergence dynamics, while a political and fiscal crisis in a systemically important European country could trigger a return to crisis dynamics.