Jean-Claude Trichet, the European Central Bankâ€™s former president, used to argue that one of the euroâ€™s greatest achievements was driving government borrowing costs down to match those of Germany, the regionâ€™s benchmark borrower. In recent weeks, however, fissures have emerged that reflect investor concern about the political and economic outlook for at least three of the common currencyâ€™s members.
Bond yields for France, Italy and Greece are all spiking higher relative to benchmarks. French 10-year borrowing costs have surpassed 1 percent for the first time in more than a year on fears that its presidential election will result in a victory for National Front leader Marine Le Pen, whose policy ideas are hardly market-friendly. Italy, deeply divided after a referendum on constitutional reform that led to a change in government, has the added problem of a banking industry that defies remedial efforts. And Greece is back in the news for all the wrong reasons as its creditors wrangle over the latest bailout review.
During Trichetâ€™s tenure at the ECB between November 2003 and November 2011, the average value for the spread between French and German 10-year yields was about 20 basis points. The gap has been widening for several months; this week, it reached a three-year high of 61 basis points.
The French election is getting messy. Le Pen, who would attempt to drive France out of the European Union, leads the way with about 25 percent of the vote in recent polling. It doesnâ€™t matter that pundits are convinced she canâ€™t win in Franceâ€™s two-stage system; bondholders remember being told Donald Trump wouldnâ€™t become US President and the UK wouldnâ€™t vote to quit the European Union.
Italian yields spent the first half of last year below those of Spain. After crossing at the end of June, Italyâ€™s 10-year borrowing cost has marched steadily higher compared with its peer. This week, the gap climbed to its widest level in four years at 70 basis points.
Italian unemployment is stuck at 12 percent, youth unemployment is more than 40 percent, consumer confidence and retail sales are declining, and an early election looks increasingly likely. Efforts to find a private solution to the woes of the ailing lender Monte dei Paschi di Siena failed, prompting the government to set aside 20 billion euros ($21.4 billion) of public money to recapitalize banks struggling to cope with about 355 billion euros of bad loans.
And Unicredit, the countryâ€™s biggest bank, expects to record a loss of 11.8 billion euros for 2016 â€” almost equal to the 13 billion euros itâ€™s hoping to raise in a capital increase. With Unicredit shares down by more than 12 percent in recent days, that capital raising exercise gets harder and harder.
In short, both the Italian economy and its banking system are failing to reach the post-crisis escape velocity that other euro members have achieved.
Itâ€™s Greece, though, that remains the sickest man in the euro. Greeceâ€™s two-year yield has soared by more than 2 full percentage points in the past week, climbing above 9 percent to its highest level since the middle of last year. The gap between 10-year Greek and German yields has also climbed, reaching its widest in 12 weeks.
The International Monetary Fund says Greeceâ€™s government debt burden will reach a staggering 270 percent of its gross domestic product by 2060, up from about 180 percent currently. It wants European officials to grant more debt relief to avoid that scenario.
For its part, the European Stability Mechanism, which is providing Greeceâ€™s bailout loans, says thereâ€™s â€œno reason for an alarmistic assessment of Greeceâ€™s debt situation.â€ Greece has yet to implement two-thirds of the conditions attached to the disbursement of the next tranche of aid, and with elections looming in France and Germany, European officials are warning the nation that the standoff needs resolving by the time euro region finance ministers meet on Feb. 20.
â€œWe need a new cycle of economic and social convergence,â€ Portuguese Prime Minister Antonio Costa told reporters at a meeting of southern European leaders in Lisbon. â€œA better coordination of budget policies and of budget policies with the ECBâ€™s policy are essential conditions for growth and employment.â€ Costaâ€™s own debt-to-GDP ratio is the third-highest in the euro region, behind Greece and Italy, and shows little sign of improvement.
Unfortunately, divergence seems the more likely scenario for the euro region in the coming months, both politically and economically. Add in the tricky task facing the European Central Bank as it negotiates between German demands to tighten monetary policy with the economic needs of the euroâ€™s weaker members, and itâ€™s clear that those bond-market alarm bells are a reminder that Brexit isnâ€™t the only cloud on Europeâ€™s horizon.
Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of â€œComplicit: How Greed and Collusion Made the Credit Crisis Unstoppable.â€