A major turnaround! Political stability and fiscal improvement become the key to attracting investments, as bond investors "abandon legality for intent."

As the market prepares for next year's elections in Italy and France, an increasing number of bond investors are betting that Italy's political upheavals will be calmer compared to Frances. Over the past few months, asset management companies Barings and Carmignac Gestion have been ramping up their investments in Italian bonds, joining other investors, including MFS International, who are optimistic about Italian bonds. The influx of capital is driving Italian bond yields down to levels below those of French bonds with the same maturitytraditionally, French bonds are viewed as safer, but now investors are demanding higher risk premiums. French bonds are being asked for a premium due to higher political risks. Many investors are currently steering clear of French bonds as the country prepares for budget negotiations next month, which are likely to become a political flashpoint and set the tone for the presidential election next spring. Meanwhile, investors believe that the days of fiscal mismanagement and political turmoil in Italy are a thing of the past. Italian Prime Minister Giorgia Meloni is seeking to win a second term. Barings investment manager Brian Mangwiro, who has been buying Italian bonds with maturities of up to ten years, stated, "This may be one of the longest and most stable governments we've seen in Italy for quite some time. We still believe that the risk of significant political turmoil in Italy is quite low, which is part of the reason Italy has become one of our largest overweight positions." This sentiment marks a sharp turnaround in the bond market's view of Italy compared to 2022, the year Meloni first took office and Italian bonds were sold off. Now that Italian bond yields are lower than those of French bonds, it reflects a structural shift in the European bond market, a significant reversal since the eurozone debt crisis. In recent months, global bonds have faced pressure due to concerns about rising oil prices pushing up inflation, and eurozone bonds are no exception. However, Italian bonds are becoming an unexpected safe haven in the region. This reflects the market's optimistic view of Meloni's commitment to controlling Italy's fiscal deficitby contrast, the current French government may struggle to achieve similar goals given the rising popularity of populist politician Marine Le Pen. Reports suggest that Meloni is considering calling for an early election, potentially months ahead of the legally mandated deadline of late 2027. However, the prospect of an early election does not seem to deter investors from continuing to buy Italian bonds. Carmignac Gestion fixed income manager Marie-Anne Allier remarked, "Italy seems to be a country that at least can provide political stability, and at least its debt-to-GDP ratio will decline." "This is a significant advantage compared to other European countriesexcept for Spain, particularly when compared to France and Germany." It is reported that Marie-Anne Allier began buying Italian bonds this year while simultaneously shorting French bonds. Natixis SA interest rate trader Youness Boukakiou noted that the positive momentum for Italian bonds has been strengthening in recent months. He pointed out that buying Italian bonds maturing between three to ten years has become one of the most popular trades this summer. Meanwhile, he added that many investors in the market have been avoiding French bonds. Youness Boukakiou stated, "If you want to buy some yield-generating assets in the European government bond space, you now have two choices: France or Italy. And based on the current situation, Italy looks to have the better prospects." Furthermore, according to Larissa de Barros Fritz, a senior interest rate strategist at ABN Amro Bank, another favorable factor for Italy is that only 9% of its sovereign bonds are held by investors outside the eurozone, far lower than France's 26%. Regional investors are more likely to withstand event risks and hold the bonds until maturity. Meanwhile, 14% of Italian government bonds are held by domestic households, while the corresponding figure for France is zero. Larissa de Barros Fritz stated that this fact "provides support in these current times." Annalisa Piazza from MFS International maintains an overweight position in Italian bonds. If political stances lead to a sell-off of Italian bonds, which she believes is unfounded, she would consider increasing her position further. She expressed, "If the market experiences significant volatility, and if the market panics as a result, I would buy."