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Is the Sovereign Debt Bubble Bursting?

As France and Spain prepare for their first auctions of long-term debt since ratings agency Standard & Poor’s downgraded their credit rating on Friday, officials have been at pains to reassure international markets that their bonds are still a safe investment.

European Union Flag
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European Union Flag

The sale of shorter-term maturities on Monday and Tuesday appeared to demonstrate that investors had not been scared away by the downgrades, with yields falling and demand remaining firm.

But a far bigger test looms on Thursday, when both Spain and France will sell 10-year bonds.

Some analysts remain skeptical and doubt that euro zone bonds are a sound investment.

“The markets are gradually getting used to the idea that sovereign debt is not safe at all,” Matthew Lynn at Strategy Economics said in a note.

“There is some significant risk of capital losses by investors. It is no longer a completely safe asset,” he said.

He believes that the French downgrade from AAA last Friday to AA+ is part of a wider crisis of the sovereign debt market.

“Throughout the developed world, the sovereign debt bubble is slowly bursting. The UK and Germany will be the next two countries to lose their triple-A rating,” Lynn said.

He believes that over time, the borrowing costs for all the developed nations will rise to around 7 percent for 10-year debt.

“What the French downgrade really (signaled) was the slow death of the sovereign bond market,” he wrote.

“By 2020, interest rates of 7 percent or more will be common for all the developed countries. The era of cheap government borrowing will slowly come to an end,” according to Strategy Economics.