The eurozone debt crisis has underscored the gulf between the strong and the weak members of the pack, and nowhere is this more evident than in the bond markets.
For bond markets have become a microcosm of the broader meltdown under way in the monetary union.
The eurozone’s strong are led by Germany, which is way out in front as the number one safe haven. The powerhouse of Europe is experiencing record low bond yields, reflecting cheap borrowing costs.
At recent auctions for short-term debt, investors have essentially paid the German government for the pleasure of holding its debt. Last week, Germany issued two-year bonds at zero interest – a record low for such bonds. The week before, it paid the lowest rate in its history for 10-year borrowing.
On the other hand, we have the weaker members. Greece has been forced out of the capital markets, while Spanish and Italian bond yields continue to hover around the danger level of 6pc, which is considered the point at which the cost of borrowing become unsustainable.
Investors are rushing to buy the eurozone’s safest bonds, certain that Germany’s financial future is assured, while giving the likes of Spain and Italy a wide berth.
While the current political and economic stalemate prevails, there is little to suggest such behaviour will change. “Given the policy vacuum, I can’t really see a floor for [German] bond yields at the moment. Yields will continue to get lower at the 10, 20 and 30-year end,” said Lyn Graham-Taylor, a fixed income strategist at Rabobank.
“If you’re very concerned about the future, you look to invest in the safest and most liquid asset you can find. You will just be concerned about getting your money back.”
Britain is also considered a relative safe haven amid the current crisis, with the Government benefiting from record low borrowing rates.
Clearly it benefits from the fact it is not a eurozone member state, but a credible deficit reduction plan, and a guaranteed buyer of bonds in the form of the Bank of England have also helped to push British yields down.
The yield on benchmark UK 10-year bonds was around 1.6pc yesterday, while the yield on equivalent German bonds was 1.2pc. France has to pay a little more for its debt, but yields are still low, at 2.3pc yesterday.
The Spanish government, on the other side of the coin, will continue to pay the price for a banking system which investors fear is on the brink of collapse.
Until a convincing bank recapitalisation plan has been put into action, most likely through a transfer of bail-out funds via the Spanish sovereign from the European Stability Mechanism, yields are likely to stay around the 6pc mark. Yesterday they were at 6.4pc.
Without a Spanish resolution, focus would shift to Italy and it would not be pretty, as Mr Graham-Taylor explains. “Italy is too big to fail so you would be at the end point of the crisis. Something major would have to happen.”----
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