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Watch the yield spread
October 27, 2008
To get an idea of how the global financial crisis is testing the stability of the eurozone, look at the ever-widening spread between the yields on German and Italian 10-year government bonds: 25.8 basis points one year ago, 69.6 one month ago, 72.3 one week ago and 95.6 today.
With Greece the situation is even more acute: the spread between German and Greek bonds shot above 100 basis points last week for the first time since Greece adopted the euro in 2001. It is now close to 120 basis points. Portuguese, Spanish, Belgian and even Austrian and Dutch yield spreads are also wider than at any time since Europe’s monetary union started in 1999.
A widening spread means that investors judge it riskier to buy the debt of, say, Greece and Italy than the debt of Germany. Accordingly, they demand a higher premium.
For sure, it would be an exaggeration to say that spreads on today’s scale imply serious doubts among investors about the ability of Greece and Italy to honour their debts. But they do imply that investors lack full confidence in Greek and Italian fiscal policies.
They also serve as a reminder about the uncomfortably high levels of Greek and Italian public debt. Finally, they hint at a degree of uncertainty among investors about the cohesion of the 15-nation eurozone itself - namely, whether Greece and Italy are economically strong and fiscally disciplined enough to share the same currency with Germany over the long term.
This would not be an issue, of course, if the eurozone were like the US and had a central fiscal authority to transfer revenues between flourishing states and states suffering an economic shock. But you cannot have a central fiscal authority without a much greater shift in the direction of European political union than most politicians, taxpayers and voters appear ready to contemplate.
Even appeals for closer co-ordination of macroeconomic policies among eurozone governments meet resistance. This was was seen last week in the response to President Nicolas Sarkozy’s call for new and stronger arrangements for joint policymaking in the euro area.
Sarkozy’s proposal had its flaws and, in any case, such appeals coming from France are always liable to be interpreted as an attempt to place the European Central Bank under political control. Nonetheless, Sarkozy put his finger on the problem.
The global financial crisis is beginning to test Europe’s ability to operate a multinational monetary union without closer political and institutional integration. Since 1999, Europe has had its cake and eaten it: the pleasure of a single currency that symbolises European unity, without the pain of a political union unpalatable to so many of its policymakers and citizens.
But as the bond yield spreads show, if the financial crisis gets any worse, Europe will find itself facing some extremely difficult choices.
Oh great, just what we needed…another “funding expert” has appeared. Let me ask you this? Where was benchmark Bund/BTP 12yrs ago?
12yrs ago the BTP was trading 600 over, now I had just left Italy 4 years before, and I can assure Italy was no 3rd world country.
Please please, stop commeting on these matters on such a short term outlook.
This is not a credit crisis, this is a devolution of relative value models, consequently your 6yr outlook on bond spreads is frankly useless.
I’m sorry to be so blunt, but somebody has to say it.
Posted by: AJSG | October 27th, 2008 at 2:22 pm | Report this commentI just wonder if those “investors” are aware that Italian banks are the most solid in Europe and they NEVER asked for State help during this cris and NO ONE risked bankrupt,if they know that Italian families has the LOWEST debt in Europe,that the TOTAL debt of a country is the SUM of Public and families debt:they “widen the spread” not knowing that the total debt is 80% of PIL in Italy,100% in Germany,France and Spain.This funny lack of skill is worrysome more than tha so called “Italian debt”.
Posted by: stefano de santis | October 27th, 2008 at 4:34 pm | Report this commentoh yes, they’re watching the little-brits, eagerly waiting for the EMU to fall apart, like vultures
Posted by: koen | October 27th, 2008 at 7:50 pm | Report this commentI believe that the spreads between the yields of debt, issued by different American states still is bigger than the European spreads
how would you know that they “hint at a degree of uncertainty among investors about the cohesion of the 15-nation eurozone itself”
is it based on a survey of investors? or is it a product of your ‘eurosceptic’ imagination?
of course, investors flee more to German bonds than to Italian bonds, but that doesn’t mean that they think that the EMU is falling apart
and what’s the economic logic behind it? if Iceland were a member of the EMU, would its problems have led to the end of the EMU? don’t think so
a country like Italy might be tempted to step out of the EMU, f.i. because it wants bigger deficits, but that wouldn’t mean the end of the EMU either
AJSG - it is true that the Italian/German yield spread was enormous in the mid 90’s. But it is surely significant the trend of convergence in yields seen after the launch of the euro has very clearly been reversed in the past year.
This is not just a trend relating to Italian and Greek debt, but also a basket of debt from other eurozone states which was previously clustered around the Bund in terms of yield.
See:
http://openeuropeblog.blogspot.com/
Posted by: Hugo | October 27th, 2008 at 11:26 pm | Report this commentThe 1992 Maastricht Treaty (16 years ago!) used the words Economic and Monetary Union: not just a Currency Union but also an Economic Union.
First of all the Maastricht Treaty should be applied and the meeting between EUROZONE member states (Eurogroup) establishing common objectives was a first step, but not the last.
Eurogroup should give birth to a permanent Institution with a President which can match ECB´s Trichet, not eventual meetings from time to time without order.
A Governing Council in Eurogroup taking decission at an Eurozone level is necessary so it can send a message of unity:
“The Institutional Board of Eurogroup, headed by its President Delors, has announced a common statement about the investment of Euro 1,5 Trillion as a financial guarantee of the Eurozone financial system……”
Posted by: Enrique Costas Mira | October 28th, 2008 at 4:02 am | Report this commentSir,
Posted by: John Angelopoulos | October 28th, 2008 at 11:45 am | Report this commentWhile the spread among euro memebers is a useful message, more relevant to European people is the “spread” of the euro-based bonds versus those of countries that did not (or could not yet) join: Iceland, Denmark, Hungary (who now are talking in their public media of express entry to save themeselves even if not really possible), Baltic states, Romania etc.
Why don’t you compare Greek bonds with UK’s before and after Greece joining the euro?. Though I dread the consequences of increasing spreads, I cannot help but shiver at the thought of Greece facing this crisis with Drachmas. This is the most important consideration. Starting from this the reasonable conclusion can be reached by turning your arguments upside down landing them on their feet, namely that all the other integration to support a common currency is needed in Europe and not to abolish the best stabilising tool we ‘ve got.
I disagree fundementally with the argument that the widening gap of euro- based bonds highlights the risk to the EMU falling apart - this is a short sighted and fanciful assesment to say the least. The part of this blog I agree with is the fact that, Eurozone countries must develop a political union that goes hand in hand with economic union. It is clear the Eurozone will not survive or prosper, without taking clear action to develop the politcal institutions that can underpin the EURO. The leaders of the EU must get tough - either your in or out of this project. The financial crisis offers a once in a lifetime opportunity to explain clearly and concisely to the citizens of the EU - most notably the EUROZONE the dangers of inertia. We must act and act now.
Posted by: KWM | October 28th, 2008 at 2:27 pm | Report this commentIn my opinion, one of the roots of the spread problem in Europe ( and in the USA ) is lack of Exports:
a) Right now, exports to Russia, Latin America , USA,Canada,among others , should be the top priority for the European politicians,the small machinery manufacturer,farmers,services firms,etc., are bleeding to death in Europa ( as well as the rest of the world without any fluid finance) , right now is Trade and Commerce the best solution ,and of course cutting down on Defense for the time being is a must….Secretary of Defense Gates of the USA has today reach out to Russia,Middle East, Asia and others for dialog in cutting down the massive expenses in Defense, and in nuclear numbers too, but will the politicians listen to common sense ? or to the Arms Dealers ,Military Contractors,Weapons Manufacturers and their Lobby’s ? who will the listen to ?
most likely they will listen to the warmongers, just look how Georgia is going to spend all the Aid Money in missiles and radar-radio-hacking networks instead of bridges,roads,power plants ,mobile communications and farming,just watch…
b) and what is amazingly sad is to see the media refusing to answer the key questions ? who pushed all these “derivatives,mortgage-backed-securities,
credit-default-swaps,shorts,etc.” ? who made the huge profits from them ? all these “Zertifikaten” ? …total silence !!! and not only that, to distract from these frauds, now they try to blame the governments coming to the rescue as ” picking winners and losers” ! so these incompetent and corrupt bankers will end up blaming the tax payers for bailing out the bankers ! isn’t wonderful?
just look at VW ,where the Hedge-Funds shorting VW and Porsche are trying to blame everybody but themselves, even when they had bet against all involved and just for profits, amazing !
c) Portugal,Spain,France,Italy,Greece, the South of Europa, must become an engine for solar,wind, water desalination,greenhouse farming, electric-hybrid plug-in motors,ultra-light helicopters ,vacations and shipping,etc.,Europa needs 12 months a year home grown fresh vegetables and fruits,fresh fish and sun…and the whole continent should/must invest in batteries,everything digital today uses batteries, its one of the best investments today, be fuel-cells , lithium-ion or polymer-ion or….it’s batteries ,solar cells or a manual crank…that’s another important spread.
Posted by: financialtools1@gmail.com | October 28th, 2008 at 8:46 pm | Report this commentIceland has already lifted interest rates to 18% from 12% after their failed pipedream cut to 12% from 15% a couple of weeks ago.
Now it is the turn of the UK with the Bank of England lifting interest rates to 8% before the end of the year trying to attract some liquidity from the Eurozone…but that will lead Britain into a deeper Recession.
Posted by: Enrique | October 28th, 2008 at 9:14 pm | Report this commentHugo…since late 2006 we have experienced the most widespread collapse of all asset correlation models since the Assyrians started counting sheep on wax tablets…and this banale article speaks of a minor correction within 8% of 20yrs hist. sprd. as a disfunctional element of European fiscal an political stability.
Fundamentally Mr. Barber does not understand the basics of the subject upon which he comments.
I remember clearly the last time this kind of talk came out of the pink paper…they were talking about the impending default of Turkey, this was 2002 and as usual they were categorically wrong.
Posted by: AJSG | October 29th, 2008 at 10:14 am | Report this commentStefano, the Italian banks are not the most solid in Europe. Unicredit is a shamble; Profumo lied to everybody 12mths ago declaring that their sub-p exposure was less than 1bln. Yet we know for a fact that their new German aquisition has over 9bln in their London book alone in Q4 2007.
You telling me that Bank Austria, HVB, Kredit, etc has together less than 1bln in toxic assets? If you believe that you believe that Naples is a beautiful city.
Do you know how many blns in funding the ECB has been giving the Italian banks every single day?
Bund/BTP spread doesn’t reflect the real risks to the Italian economy, if it wasn’t for the Euro subguarantee we should be trading 800 over…not 80.
Posted by: AJSG | October 29th, 2008 at 10:42 am | Report this commentI totally disagree with AJSG.First of all i never believed tbat Naples is beautiful city,nor i think that Italy is Naples or America is South Bronx.No one knows the total amount of toxic fund in a bank until it goes belly up like Northern Rock.I just can say that,as Italian taxpayer,i didn’t give a single cent to help Unicredit or any other of the enormous number of medium and small sized banks we have in Italy.If Profumo lied,he didn’t lie to us citizens paying taxes.The TRUE dimensions of Italian economy are,as IMF tells yerarly,500/550 BILLIONS $ more than the official,due to the black economy.Black economy is ECONOMY:it’s houses,autos,computers and else bought by people who dodges taxes.It’no good,of course,but it’s better than NO ECONOMY AT ALL.A lot of magazines and newspapers attacks Berlusconi and Italy daily for this and else,but the truth is that,when the West is in troubles,somebody calls us to join the rescue crew.There is no risk in Italian economy,because Italians are strong savers,and HALF of our national debt is in the pocket of the Italians,in terms of the so called BOT,BTP,CCT .If you are trying to find where the danger of 80 to 800 comes,look at those who buys something paying with debts,which means with nothing.This sick behaviour doesn’t belong to us.
Posted by: stefano de santis | October 29th, 2008 at 3:51 pm | Report this comment“No one knows the total amount of toxic fund in a bank until it goes belly up like Northern Rock.”
Whoa…the bank is supposed to know…NR did not suddenly discover under the carpet a whole bunch of bad assets, they could simply no longer borrow in the interbank market…and NR issues started months and months before they went belly up…everybody knew about it…
“If Profumo lied,he didn’t lie to us citizens paying taxes”
Ermm…yes he did, he must know the content of these books, if he doesn’t it means he cannot read…KMPG signed off HVB’s 2007 accounts marking their level 3 assets at 95 cents to the dollar…that is outright criminal…
You are currently lucky that the ECB dropped its collateral quality floor, and that Bank Austria, HVB etc etc can get trillions in funding…
“There is no risk in Italian economy,because Italians are strong savers,and HALF of our national debt is in the pocket of the Italians”
There is a huge amount of risk in the PIGS (Portugal Italy Greece Spain)…but Italy finds itself in the unfotunate situation where exponentially rising pension funding costs married with a huge issuance package…(remember when they issued 6bln 3mth BOTs? 6bln???!!!), projects over 4% deficit to GDP ratio…Poland is at -3.54 and Portugal -3.91%…
There are still too many banks in Italy, and more importantly too many bank employees. Unicredit is closing its Rome offices as we speak…but they have not been able to fire a single person…
Posted by: AJGS | October 29th, 2008 at 5:03 pm | Report this commentOh,too gentle to call un PIGS.Somebody else used to call us “CLUB MEDITERRANEE”,which is more correct.You still speak about the famed 4%ratio:but you call HUNDRED what is ONE HUNDREDTHIRTY,as the French and German auto exporters knows very well.You do NOT export ONE MILLION CARS yearly in a country with less than 2,5 trillions GDP.So please do not mention Poland and Portugal,they belong to the band of Snow White.We can afford this and more,considered that,as i said,we are not used to try to turn NOTHING into SOMETHING with those tricky “Hedge funds” and “Subprimes”.If somebody likes the world “sub”,better he buys a ticket for a trip into a yellow submarine.Anyone is free of thinking that Italy is risky,but,when you speak from a country that is funding his banks with 200 billion coming from the pockets of taxpayers,better you think to your troubles.I have been buying Italian state Bonds from the years 70,and i feel very good,after 35 years.Somebody who bought LEHMANN would dream to swap my place with his.And now let’s wait for the next elections in Germany,with the bosses of ex DDR knocking at tht door.Will you still buy their bonds,and,after some year,find into your pockets DDR marks? You do not run such a danger with Italian bonds.
Posted by: stefano de santis | October 30th, 2008 at 10:46 am | Report this commentOh,too gentle to call un PIGS.Somebody else used to call us “CLUB MEDITERRANEE”,which is more correct.You still speak about the famed 4%ratio:but you call HUNDRED what is ONE HUNDREDTHIRTY,as the French and German auto exporters knows very well.You do NOT export ONE MILLION CARS yearly in a country with less than 2,5 trillions GDP.So please do not mention Poland and Portugal,they belong to the band of Snow White.We can afford this and more,considered that,as i said,we are not used to try to turn NOTHING into SOMETHING with those tricky “Hedge funds” and “Subprimes”.If somebody likes the world “sub”,better he buys a ticket for a trip into a yellow submarine.Anyone is free of thinking that Italy is risky,but,when you speak from a country that is funding his banks with 200 billion coming from the pockets of taxpayers,better you think to your troubles.I have been buying Italian state Bonds from the years 70,and i feel very good,after 35 years.Somebody who bought LEHMANN would dream to swap my place with his.And now let’s wait for the next elections in Germany,with the bosses of ex DDR knocking at tht door.Will you still buy their bonds,and,after some year,find into your pockets DDR marks? You do not run such a danger with Italian bonds,be sure.
Posted by: stefano de santis | October 30th, 2008 at 10:48 am | Report this commentStefano,
FYI: Il Sole-24 reports the Italian government could approve a decree to support the banking sector today in which the Treasury would underwrite subordinated perpetual bonds or new hybrid instruments of banks as a means of recapitalisation without diluting the banks’ share capital. (From FT Alphaville.)
Posted by: Carlomagno | October 31st, 2008 at 4:38 pm | Report this commentThe Italian Government COULD APPROVE.Somebody else APPROVED and now he must find billions in the taxpayer’s pockets.I just wander how the German Government will find 470 billions Euro,for example:this will cause an enormous growth of taxes and /or an enormous growth of the interst rates paid by their State funds.We do not run such danger,in Italy.
Posted by: stefano de santis | November 1st, 2008 at 4:38 pm | Report this commentWhat are the effects of the higher yield spread?
How could a widening gap between German and Italian sovereign debt yield tear apart the monetary union?
Tony Barber’s comment remains somewhat vague on this point and I would appreciate any explanation.
Posted by: Giuseppe Garibaldi | November 3rd, 2008 at 2:42 am | Report this comment@ Giuseppe Garibaldi.
I am afraid that you may be waiting a long time for an answer as the underlying assumption by Tony Barber is fundamentally erroneous. If anything, the higher spreads may hasten the day when governments within the Euro-zone realise that there is no such thing as a free lunch. Ireland is presently finding out the hard way.
Posted by: J.L. | November 3rd, 2008 at 8:55 pm | Report this comment[…] More than six weeks ago, I drew attention to the way that the global financial crisis was testing the eurozone’s stability by widening the yield spreads between German and other government bonds. This topic won’t exactly dominate the two-day European Union summit that starts in Brussels on Thursday, but you know what? Perhaps some leader or other - Angela Merkel, for example - should mention it. […]
Posted by: FT.com | Brussels Blog | Be bold, Angela, and talk about yield spreads at the EU summit | December 10th, 2008 at 2:14 pm | Report this comment