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Whatever happened to the bond vigilantes? Euro zone investors are shrugging off rising national debts, missed growth targets and political uncertainty. Having first terrorized policy makers into austerity, they now seem to think they will be saved by central banks. This relaxed approach leaves a lot to trust.
The fall of Italy's 10-year bond yields below 4 per cent for the first time since 2010 on the mere talk of a new government highlights the willingness of bond markets to take an optimistic view. Spanish and Portuguese yields are also near multiyear lows. The catastrophe of the Cyprus bailout seems to have been forgotten. The European Commission's willingness to grant countries more time to meet deficit targets has barely raised an eyebrow.
It would be tempting to chalk this optimism up to improved government finances. The main driver, however, is central bank largesse. The pledge from European Central Bank chief Mario Draghi to save the euro still reassures. Japanese money printing, meanwhile, may push Asian investors into European bonds. A recent rash of poor economic data across Europe is fuelling hopes of a rate cut and further action from the ECB is boosting all euro zone debt, not just peripheral securities.
And it is not only in the periphery that bonds are being inflated by cheap money. Arguably, they are only joining other central bank-distorted bond markets, such as in the U.K. However, there's a danger that markets are getting ahead of themselves. Euro zone bond prices may be converging but the real economies of Spain and Italy are still way behind northern Europe. Hopes for euro zone integration, meanwhile, are stalling: Plans for a banking union are in danger of being delayed by German requests for a treaty change.
More docile bond markets make a welcome change from the last two years, when rising yields risked placing governments in a spiral of ever-rising debt. Without market pressure, however, politicians may delay reforms. Looser deficit targets in the euro zone may avoid austerity-induced trauma, but growth will only come if politicians push through painful changes.
The renewed risk appetite from global buyers could even backfire. The more governments can spread their debt burden from domestic investors to international ones, the more they may one day think about hair-cutting them.