European Fiscal Stress Becomes New Trigger for US Treasury Selloff

European Fiscal Stress Becomes New Trigger for US Treasury Selloff

TREE NEWS reports: US 10-year Treasury yields briefly climbed to 5.349% on Monday, the highest since April 2002, while the 30-year yield touched 5.703%, also a 24-year high. The move came as French 10-year yields rose to their highest level since 2002 and the spread over German Bunds widened to the most since the eurozone debt crisis. The euro has fallen about 5% against the dollar this year and has declined for four consecutive weeks.

Analysts say deteriorating European fiscal positions and political instability, compounded by the outlook for US midterm elections, could further amplify bond market volatility in the near term. Wall Street does not yet see Europe’s situation escalating to the scale of the 2009-2012 PIIGS debt crisis, but European uncertainty has become a new variable in the Treasury selloff.

Multiple Pressures Push Treasury Yields to 24-Year Highs

The US 10-year Treasury yield peaked at 5.349% during New York trading, the highest since April 3, 2002; the 30-year yield jumped to 5.703%, also the highest since May 2002. The 10-year yield rose 0.87 percentage points in the third quarter alone, the largest quarterly increase since the first quarter of 1994.

Structural factors driving yields higher are stacking up. The ongoing Middle East war and elevated oil prices keep inflation re-acceleration risks alive. The ISM services PMI price sub-index rose to 74.0 in September, the highest since July 2022. CME FedWatch data show federal funds futures now price a 67.8% probability of one more Fed rate hike this year and an 18.8% probability of two.

The Trump administration’s tax cuts and military spending on the Iran war have sharply expanded the fiscal deficit, increasing Treasury supply and creating a vicious cycle of rising yields. The Treasury will auction $58 billion of 3-year notes, $39 billion of 10-year notes and $22 billion of 30-year bonds from the 6th to the 8th. In addition, a boom in AI infrastructure construction, led by hyperscale data center operators, has generated massive corporate bond issuance, shifting funds from Treasuries to high-grade tech debt. Morgan Stanley predicted in July that AI-related corporate bond issuance would more than double this year from last year to $570 billion. South Korea, Japan and European countries selling Treasuries to defend their currencies are also important drivers of higher yields.

UK and French Bond Markets Under Pressure, Euro at 17-Month Low

Turmoil in European bond markets is transmitting to US Treasuries. The UK 30-year gilt yield briefly rose to 6.020%, the highest since 1998 and the first time a G7 long-term government bond yield has exceeded 6% since Italy during the 2012 eurozone debt crisis.

French 10-year yields rose to 4.963%, the highest since 2002, with the spread over German Bunds widening to 1.4 percentage points, the widest since the eurozone debt crisis. Italian and Greek yields also jumped sharply as hedge funds unwound concentrated arbitrage positions in European government bonds. Eurozone inflation rose 3.8% year-on-year last month, the largest increase since September 2023. The euro fell 0.8% to $1.1161 during Asian trading, bringing its year-to-date decline to about 5%.

French Fiscal Woes Spark National Protests, Bond Market Sees Foreign Outflows

France is the most concentrated manifestation of European fiscal stress. French national debt reached €3.596 trillion as of end-June, or 119% of GDP, and this year’s fiscal deficit is expected to widen to 5.4% of GDP from 5.1% last year. The government’s budget draft published on October 1 proposes cutting €43 billion in spending, with education spending rising only 1.7% in nominal terms, below inflation.

Fiscal austerity has directly ignited social tensions. Since a high school teachers’ strike in Créteil, a Paris suburb, on the 17th of last month, nationwide protests have spread. As of the 5th, 400 to 500 schools across the country had been fully or partially closed. During the protests, 24 schools were set on fire or damaged and 78 staff were injured; more than 5,060 people have been detained, 87% of them minors. Average education spending per middle school student was €11,660 in 2024, lower than €11,910 in 2010.

As France’s fiscal outlook deteriorates, global investors are accelerating their exit from its bond market. Japanese investors have net sold about ¥356 billion of French government bonds this year, while net buying ¥658 billion of German Bunds and ¥775 billion of Italian government bonds.

Spain’s Housing Crisis Triggers Political Gamble, Europe’s Energy Woes Add to Global Risks

Spain’s housing shortage is also weighing on global bond markets. On the 23rd of last month, an 87-year-old woman, Maricarmen Abascal, was evicted from a Madrid apartment she had lived in for more than 70 years because her pension could not cover soaring rent. The images, broadcast on television, triggered large street protests. Spain has long faced a housing shortage, partly due to property speculation aimed at short-term tourism demand.

Spain’s parliament subsequently voted down two decrees on the 2nd that would have automatically extended leases to 2028, restricted short-term rental platforms, barred speculative funds from the housing market and protected vulnerable tenants. The conservative People’s Party, far-right Vox and Catalan separatist party Junts per Catalunya voted together to reject them. Prime Minister Pedro Sánchez announced on the 5th that early elections would be held on the 29th of next month, instead of next summer. Sánchez said he needs a larger progressive majority in parliament to overcome vested interests. For Sánchez, who leads a minority government, the snap election is seen as a political gamble.

From a broader perspective, Europe’s challenges go beyond fiscal and political issues. Due to the shocks of the Ukraine and Iran wars, Europe is suffering severe energy supply shortages, and its advanced technological capabilities are declining, effectively marginalizing it from the AI supply chain. This means that if European economic turmoil deepens, its spillover effects on the US bond market and Fed rate decisions should not be ignored.

Key Takeaways for Investors

• Bond vigilantes are back: The combination of European fiscal deterioration, US deficit expansion and AI-driven corporate issuance is pushing long-end yields higher across developed markets. Duration risk remains elevated.
• Watch the euro: A sustained euro decline below $1.11 could accelerate inflation in Europe and complicate ECB policy, while boosting the dollar and pressuring emerging market currencies.
• Political risk is now a pricing factor: France’s protests and Spain’s snap election show that fiscal consolidation is politically toxic. Investors should price in higher political risk premia for European assets.
• US midterms add another layer: With the US election outlook uncertain, Treasury supply and fiscal policy could remain volatile, keeping yields biased higher.
• Diversification matters: With correlations between stocks and bonds unstable, investors may want to consider gold, commodities and non-US assets as hedges.