“From a Junk Bond Sell-Off to France’s Fiscal Troubles”: Turmoil Deepens in European Bond Markets, Raising Fears of Another Eurozone Debt Crisis

Selling spreads through Europe’s junk bond market, with bond prices plunging among low-rated companies
Prolonged high interest rates and corporate asset transfers heighten credit risks as hedge fund losses snowball
France’s fiscal troubles fuel market anxiety, with risks potentially spreading across the eurozone

Turmoil is spreading rapidly through Europe’s speculative-grade corporate bond, or junk bond, market. Amid persistently high interest rates and an economic slowdown, selling has intensified among financially vulnerable companies. Losses and position liquidations at hedge funds that have invested in distressed debt are adding to downward pressure on prices across the market. France’s fiscal deficit and public opposition to austerity policies are also cited as factors fueling instability in government bond markets. Concerns are mounting that a fiscal shock originating in France could spread to other heavily indebted eurozone countries, including Italy.

Selling Intensifies in European Junk Bonds

The Financial Times (FT) reported on the 2nd, local time, that bond selling was spreading through Europe’s junk bond market, particularly among companies with low credit ratings. Selling pressure is reportedly concentrated on financially vulnerable businesses. According to global financial research firm Aranca, credit spreads—the additional yield demanded over benchmark rates such as government bond yields—on euro-denominated speculative-grade corporate bonds rated CCC widened by 2.32 percentage points from the start of this year through the end of September. By contrast, spreads on the relatively higher-rated B and BB categories rose by just 0.58 and 0.14 percentage points, respectively.

Several factors lie behind this market turmoil. Aggressive asset-transfer transactions by corporate owners are cited as a major risk. Some private equity firms have moved key assets of their portfolio companies to affiliates and other entities beyond the reach of existing creditors’ collateral claims and enforcement rights, reducing the assets available for recovery in the event of default. Stefan Chonev, founder and chief investment officer (CIO) of Sternlight Capital Partners, warned that private equity owners had already suffered substantial losses on their investments and that weak protections in bond agreements could leave creditors facing larger losses than expected.

Mounting Hedge Fund Losses

These developments have also dealt a direct blow to hedge funds heavily invested in distressed corporate debt. The flagship fund of European credit-focused hedge fund Arini Capital Management has lost 26% so far this year. The losses reflect sharp declines in the bond prices of British luxury carmaker Aston Martin and telecommunications company Altice International, both major Arini holdings. Both companies have heightened investor anxiety by pursuing transactions that weaken creditors’ prospects of recovering assets. Several credit investment teams at large multistrategy hedge funds have also reportedly been shut down, although the firms involved and the scale of the closures have not been disclosed.

The problem is that fund managers suffering mounting losses from falling prices are selling large quantities of their bond holdings to reduce risk exposure, creating a vicious cycle that drives prices down further. Simon Matthews, a senior portfolio manager at global asset manager Neuberger Berman, told the FT: “The speed and intensity of selling in distressed corporate bonds became so extreme that several prominent special-situations investment funds had to liquidate their positions urgently.” He added: “This led to further price declines.”

Expectations Grow That Interest Rates Will Stay High

Interest rate conditions are also fueling investor anxiety. In 2023, when market interest rates remained elevated following aggressive monetary tightening by major central banks, sentiment toward junk bonds actually improved. Expectations that the rate-hiking cycle had peaked eased concerns about further increases in borrowing costs. In November 2023, the Markit iTraxx Crossover index, which tracks credit default swap (CDS) rates for lower-rated European companies, fell to 374.86 basis points (1 basis point = 0.01 percentage points), its lowest level since April 2022. A similar trend continued last year. Although the tariff policies of U.S. President Donald Trump’s administration heightened uncertainty in global financial markets, expectations of interest rate cuts in Europe, coupled with investor wariness toward U.S. assets, drew money into the junk bond market.

This year, however, the situation has changed. Rising energy prices and inflationary pressures stemming from the prolonged war in the Middle East have increased the likelihood of further interest rate hikes by major central banks, fueling concerns that companies could face elevated borrowing costs for an extended period. An economic slowdown and structural changes across industries driven by the spread of artificial intelligence (AI) technology are also raising doubts about financially vulnerable companies’ ability to repay their debts. One market expert said: “Unlike in the past, expectations that financial conditions will ease in the near term have weakened, while concerns have grown that companies unable to withstand high interest rates could fail to refinance or default.” The expert added: “Sentiment toward junk bond investment appears to be driven less by the absolute level of interest rates than by expectations for the future path of monetary policy and companies’ ability to service their debts.”

Table 1. Main Causes of Turmoil in European Bond Markets

France’s Fiscal Instability Comes into Focus

Large-scale protests spreading across France have also amplified turmoil in European bond markets. The demonstrations began in mid-September with demands by education staff and students for better educational conditions, before expanding into nationwide anti-government protests as grievances over cuts to public services and the rising cost of living converged. On the 17th of last month, about 550,000 people, according to government estimates, or as many as 800,000, according to organizers, took to the streets across France. In some areas, clashes between protesters and police led to violence and looting. The government imposed nighttime curfews in key areas and deployed large numbers of police, but the demonstrations showed little sign of subsiding. Authorities estimated that 410,000 people participated in protests on the 24th of last month, while about 320,000 took to the streets on the 31st.

Underlying the protests are the French government’s severe fiscal difficulties and its resulting push for austerity. The government is seeking EUR 54 billion in fiscal savings in its 2027 budget proposal to reduce the fiscal deficit from an expected 5.4% of gross domestic product (GDP) this year to 5% next year. However, plans to freeze public-sector wages and cut public-service spending have met fierce resistance from civil servants, education staff and labor unions, intensifying conflict between the government and civil society. The government is caught in a dilemma: failure to reduce the deficit would further increase public debt and interest costs, while pressing ahead with austerity could deepen social unrest.

Could the Shock Spread Across the Eurozone?

Against this backdrop, some market participants worry that France’s fiscal instability could develop into something resembling the eurozone debt crisis that shook Europe in the early 2010s. That crisis began in earnest in 2009, when it emerged that Greece’s reported fiscal deficit figures differed substantially from its actual fiscal position. As growing doubts about Greece’s ability to repay its sovereign debt sent government bond prices plunging and yields soaring, the shock spread to fiscally vulnerable countries including Portugal, Ireland, Italy and Spain. Investors sold off government bonds issued by heavily indebted member states, driving borrowing costs sharply higher and forcing some countries to rely on bailouts from the European Union (EU) and the International Monetary Fund (IMF).

The possibility that France today harbors risks similar to those Greece faced at the time cannot be ruled out. According to the results of an internal stress test released last month by global financial information provider Morgan Stanley Capital International (MSCI), a scenario involving deeper fragmentation of eurozone financial markets would push the yield spread between French and German 10-year government bonds above its 2011 peak. The analysis suggests that selling could spread to government bonds issued by Italy and other member states, while investors shift funds into relatively safe German government bonds, sending European bank stocks and the euro lower in tandem. MSCI estimated that under this scenario, European equities would fall 15%, while a hypothetical global investment portfolio comprising stocks, bonds and alternative assets would lose 5% in U.S. dollar terms.