March 5, 2021

Off the Charts: Bond Brush Fires Spreading in Europe

The European Central Bank this week began to buy Spanish and Italian government bonds, and yields on such bonds immediately fell by more than a percentage point. But market pressure shifted immediately to France.

For France, the rise in yields must have come as a shock. At the end of last week, Standard Poor’s had gone out of its way to declare that the country deserved a Triple-A rating, and this was at the same time it was taking that rating away from the United States.

As soon as the French bond yields began to rise, rumors appeared that major French banks might be in trouble because of their holdings of government, or sovereign, debt. The banks insisted they were fine.

The accompanying charts show the trend in yield spreads between 10-year government bonds issued by Germany, by far the largest and strongest country in the euro zone, and the four other largest countries that share the common currency.

The most recent round of market worry appeared to begin on July 22, as Europe agreed on terms for the latest loans to Greece. That agreement was aimed at persuading banks that owned Greek bonds to share in the pain, and the yield spreads on Spanish and Italian bonds promptly began to rise, as speculators sold bonds issued by those countries.

At an emergency meeting on Sunday, the European Central Bank governing board reached agreement to allow purchases of bonds from those two countries. When those purchases began on Monday, yield spreads relative to Germany declined from the peaks of the previous week. But it appears that some of the speculation shifted, and France came up as a possible target, and its spread began to widen. The S. P. report on the United States had called attention to the fact that France’s debt, as a percentage of gross domestic product, was larger than that of the United States.

The difference between French and German yields on 10-year bonds rose to almost a full percentage point. That is not close to the spreads between German bonds and those of Italy or Spain, but it is the largest spread for France since the euro was established in 1999.

But the Netherlands, whose bonds had traded at wider spreads than France’s during the financial crisis in 2008 and 2009, appeared to be unaffected by speculation this week.

The first set of charts shows the changes in spreads since July 22, while the second set of charts shows the long-term trend beginning in 1994.

During the mid-1990s, anticipation of the establishment of the euro led spreads to collapse. Previously, countries like Italy had often had to pay substantially more to borrow, a fact that reflected fears of currency devaluation. With a common currency, and no provision for a country to ever leave the euro, it appeared that there was no reason for yields to be very different.

But when the financial crisis struck, bond investors began to differentiate more between countries, a trend that accelerated when first Greece and then Ireland and Portugal had to seek European help. The latest Greek deal provided that bondholders would be asked to take some losses, a fact that emphasized the risk of default to investors in other countries’ bonds.

Floyd Norris comments on finance and the economy at

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