Fundamental drivers of
Eurozone sovereign
spreads
Markets and Products Analysis
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The 10-year government bond yield of the periphery countries increased sharply during 2011-2012. The Portuguese
10-year yield reached 17.4% (30/01/2012) after S&P downgraded the sovereign credit rating on January 13. Italy’s
yield increased in November 2011 at a high 7.3% and Spain’s yield at a high 7.6% (24/07/2012).
During the �financial crisis, the German Bund has benefitted from the safe haven status.
The ECB measures announced at the beginning of 2015, have significantly lowered bond yields.
Eurozone Sovereign Spreads
3
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/14
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4/1
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6/1
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/15
12
/15
%
Selected Eurozone Countries 10-Year Govemrent Bond Yield, 2009 - 2016
Germany Portugal
Spain Italy
France Belgium
Netherlands
Source: Bloomberg, Market and Products Analysis
Spreads limited increase in July 2015 was caused
by Grexit worries (Referendum in Greece) and a
possible contagion effect on other Eurozone
countries. Specifically:
• Italy’s yield reached high (162bp) since Nov
2014.
• Spain’s yield increased to a high (161bp)
since July 2014.
• France’s yield increased to a high (48bp)
since May 2014.
In August 2015, German bund benefitted from the
risk off environment due to uncertainty regarding
China’s economic outlook. As a result, Italy (24/08:
130bp) and Spain (21/08: 144bp) sovereign
spreads widened.
Negative risk sentiment in December mainly due to
markets disappointment after ECB’s meeting and
Fed’s rate hike. Sovereign spreads in periphery
Eurozone’s countries exhibited mild increase in
December.
Increased probability for further monetary easing
measures by the ECB after the meeting in
January, contributed to decrease in Spain’s spread
versus Germany.
Eurozone Sovereign Spreads
4 Source: Bloomberg, Market and Products Analysis
70
90
110
130
150
170
190
210
230
1/1
4
2/1
4
3/1
4
4/1
4
5/1
4
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5
7/1
5
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5
9/1
5
10/1
5
11/1
5
12/1
5
1/1
6
10-Year Government Bond Yield Spread vs Bund, 2014-2016
Italy Spain
10
15
20
25
30
35
40
45
50
55
60
65
70
75
1/1
4
2/1
4
3/1
4
4/1
4
5/1
4
6/1
4
7/1
4
8/1
4
9/1
4
10
/14
11
/14
12
/14
1/1
5
2/1
5
3/1
5
4/1
5
5/1
5
6/1
5
7/1
5
8/1
5
9/1
5
10
/15
11
/15
12
/15
1/1
6
France 10-Year Government Bond Yield Spread vs Bund, 2014- 2016
Most Eurozone countries improved their credit worthiness in 2015.
Eurozone Credit Rating
5 Source: Bloomberg, Market and Products Analysis
3/9
8
9/9
8
3/9
9
9/9
9
3/0
0
9/0
0
3/0
1
9/0
1
3/0
2
9/0
2
3/0
3
9/0
3
3/0
4
9/0
4
3/0
5
9/0
5
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6
9/0
6
3/0
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9/0
7
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6
S&P Long Term Credit Rating
Spain Greece Ireland
Italy Belgium Portugal
AAA
AA+
AA
AA-
A+
A
A-
BBB+
BBB
BBB-
BB+
BB
BB-
B+
B
B-
CCC+
CCC
CCC-
CC
C
SD
AAA
AA+
AA
AA-
A+
A
A-
BBB+
BBB
BBB-
BB+
BB
BB-
B+
B
B-
CCC+
CCC
CCC-
CC
C
SD
Average sovereign credit rating (S&P, Fitch, Moody’s) is explained well by markets credit spread (swap spread).
Current sovereign credit spread in Italy and Spain theoretically implies higher swap spread.
Eurozone Sovereign Spreads vs Credit Rating
6 Source: Bloomberg, Market and Products Analysis
Italy
Portugal
Ireland
Spain
Germany
Belgium
France
Austria
Netherlands Finland
y = -0.0443x + 19.901 R² = 0.8226
-40 -20 0 20 40 60 80 100 120 140 160 180 200 220 240
Selected Eurozone countries credit rating versus 10-Year swap spread
AAA
AA+
AA
AA-
A+
A
A-
BBB+
BBB
BBB-
BB+
BB
BB-
Eurozone Economic Growth Outlook
Economic growth outlook for 2016 is expected to
remain solid, supported by the factors below:
Lower oil price
ECB QE measures
Euro currency devaluation
The IMF forecasts growth of 1.7% this year in
Eurozone.
Yield spreads increase as a response to a slowdown
in growth. In contrast, a solid growth performance is
assumed to improve creditworthiness, reducing
government bond spreads.
PMI manufacturing index is used as a proxy for the
economic activity. Recent data indicate a possible
reduction of spreads in 2016.
7
28
30
32
34
36
38
40
42
44
46
48
50
52
54
56
58
2/1
3
4/1
3
6/1
3
8/1
3
10/
13
12/
13
2/1
4
4/1
4
6/1
4
8/1
4
10/
14
12/
14
2/1
5
4/1
5
6/1
5
8/1
5
10/
15
12/
15
Eurozone Countries PMI Manufacturing Index, 2013 - 2015
Germany Spain France
Greece Ireland Italy
Source: Bloomberg, European Commission, Market and Products
Analysis
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
3
3.5
Eurozone Germany France Italy Spain Greece Portugal
% EC Forecast: GDP annual growth
2015
2016
Eurozone Countries Financing Needs 2016
Countries with high maturity debt profile may
exhibit high volatility in bond yield spreads.
Italy’s maturing debt (bonds and T bills) in
2016 is estimated around 290 bln euros.
Italy (25.4%) and Spain (18.8%) exhibit
higher financing needs as a percent of GDP
in 2016.
Recent risk off environment affects positively
german government bonds due to safe
haven status (AAA).
The decrease in long-term debt issuance in
most euro area countries may associate with
lower yield spreads.
8
Country Maturing Debt Budget deficitFinancing
Needs
Italy 23.4 2.0 25.4
Spain 15.6 3.2 18.8
France 13.7 3.4 17.0
Portugal 15.4 2.7 18.2
Belgium 15.0 2.3 17.3
Netherlands 9.5 1.8 11.3
Slovenia 15.7 5.3 21.0
Greece 3.7 3.6 7.3
Austria 5.2 1.7 6.9
Germany 5.6 -0.3 5.3
Finland 6.2 2.8 9.0
Ireland 5.8 1.3 7.1
2016
Financing Needs % GDP
0
15,000
30,000
45,000
60,000
75,000
90,000
105,000
120,000
135,000
150,000
2/1
6
3/1
6
4/1
6
5/1
6
6/1
6
7/1
6
8/1
6
9/1
6
10
/16
11
/16
12
/16
€ m
ln.
Selected Eurozone Countries Maturing Debt 2016
Italy Germany
France Spain
Belgium Portugal
Source: Bloomberg, IMF, Market and Products Analysis
Eurozone Countries Fiscal Data
The fiscal position is a proxy for creditworthiness.
The higher fiscal deficit denotes higher financing
needs. High debt issuance due to fiscal deficit
financing is expected to affect positively spreads.
A rise of fiscal deficit would be followed by the need
for fiscal consolidation program, which would have
negative spillover effects on economic outlook.
During the debt crisis, markets penalize fiscal
imbalances more strongly, attaching an extra
premium of projected public debt.
Sovereign debt becomes riskier during periods of
economic slowdown. The higher the uncertainty,
the greater the expected spreads, due to the risk of
default.
9
-12.0
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
2008 2009 2010 2011 2012 2013 2014 2015 2016
Pe
rce
nta
ge
of
GD
P
Fiscal Balance of Eurozone Countries (2008-2016)
Greece
Portugal
Spain
Italy
30.0
50.0
70.0
90.0
110.0
130.0
150.0
170.0
190.0
210.0
230.0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Perc
en
tag
e o
f G
DP
Government Debt of Eurozone Countries (2007-2016)
Greece
Italy
Spain
Portugal
Source: Bloomberg, Market and Products Analysis, IMF
ECB’s Measures Impact on Government Bond Market
The expanded asset purchase programme consists of
third covered bond purchase (CBPP3), asset-backed
securities purchase (ABSPP) and public sector
purchase (PSPP). Monthly purchases in public and
private sector securities amount to €60 bln..
In 2015, the ECB purchased €495 bln. under PSPP.
ECB allocates €115 bln. of the total purchases to
German bunds and €79 bln. to Italian bonds.
Bond purchases have weighted average maturity 8
years, indicating that the impact of the QE is higher
on 10 years bonds versus short-term bonds.
QE pushes up the market price of government bonds
and reduces yields.
After the last meeting of ECB, the President stated
that it is necessary to reconsider the monetary policy
in the next meeting in March. A possible deposit rate
cut affect the short term bond yields (2y) further.
In case that the ECB decides to expand the size of
purchase programme, the 10-year government bond
yields expect to decrease substantially.
10
Breakdown of debt securities under PSPP
15-Dec Cumulative net purchases
in mln euro
Weighted average
remaining maturity in
years
Austria 12,641 8.5
Belgium 15,896 9.5
Cyprus 285 5.8
Germany 115,625 7.0
Estonia 48 2.5
Spain 56,817 9.7
Finland 8,086 7.6
France 91,767 7.7
Ireland 7,583 9.4
Italy 79,209 9.3
Lithuania 1,107 6.0
Luxembourg 1,115 6.1
Latvia 684 5.9
Malta 282 9.6
The Netherlands 25,612 6.5
Portugal 11,220 10.4
Slovenia 2,228 8.0
Slovakia 4,622 8.6
Supranationals 60,104 7.0
Total 494,930 8.0
Source: Bloomberg, Market and Products Analysis
Recent Markets Turmoil and Sovereign Spreads
Risk sentiment plays an important role in bond
markets. Core countries government bonds
(Germany, Finland, Netherlands) are considered as
safe heaven assets, implying low bond yields in case
of risk-off environment. In contrast, periphery
countries bonds exhibit positive correlation with risky
assets.
VIX is a measure of implied volatility of S&P 500
index. High VIX readings indicate significant risk off
sentiment.
Recent elevated VIX was combined with increase of
sovereign spreads in periphery countries.
German 10-year Government bond yield dropped on
February 1 2016 to a low (0.304%) since April 2015,
mainly due to safe heaven status and the expectation
that the ECB will cut the deposit rate.
Major political risks in 2016:
More than one month after the parliamentary
elections in Spain, a new government is still not
in sight. A possible left wing alliance would have
a significant negative effect on bonds due to
increased risk of loose fiscal policy and Catalan
secession. Possible new elections in spring.
Refugee crisis could affect German political
landscape in 2016.
Political instability drives bond yields higher.
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0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Spreads & political index of Portugal (2005-2014)
Portugal spreads
Political index
85
90
95
100
105
110
115
120
125
130
135
140
10
15
20
25
30
35
40
45 Italy - Germany 10-Year Government Bonds Yield Spread & VIX index, 2015 - 2016
Implied Volatility Index (Vix)
Italy 10-Year Spread
Source: Bloomberg, Market and Products Analysis
Performance Bonds YtD
Since the start of the year, Eurozone core
countries (Germany, Netherlands) 10-Year
government bonds have exhibited significant
gains (around 3.5%), mainly due to increased
demand for low risk assets.
Spain 10-Year government bonds underperformed
vs Bund since the beginning of the year, mainly
due to political instability after the general
elections.
Greece government bonds dropped substantially
in 2016 due to uncertainty regarding the
conclusion of the review.
The revived expectations that the ECB will adopt
further monetary easing measures as well as the
projections that the Fed will delay its second rate
hike, support Eurozone government bonds.
Demand for periphery Eurozone government
bonds remains solid, mainly due to ECB monetary
measures.
12 Source: Bloomberg, Market and Products Analysis
-9.0 -8.0 -7.0 -6.0 -5.0 -4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0
Germany
Netherlands
France
Finland
Austria
EFSF
Spain
Italy
Slovenia
Slovakia
Cyprus
Greece
10-Year Government Bond Price YtD Change (%)
As of Feb. 1, 2016
Econometric model
Our econometric model focuses on:
The determinants of 10-year government bond yields versus Germany
A panel data analysis
A 2SLS method of estimation
Our analysis, examines:
The evolution of the fundamental drivers of Eurozone sovereign spreads.
The evolution of spreads in the Eurozone.
The sensitivity of spreads to fundamentals, using an econometric model based on panel data methods.
The results largely agree with existing literature.
13
Spreads(-1) spreads
Government debt spreads
Industrial prod. spreads
Volatility spreads
ECB assets spreads
Results From Econometric Model
14 Source: Market and Products Analysis
Conclusion
15 Source: Market and Products Analysis
Outlook
Economic
activity
Government
debtCPI Political risk
ECB total
assetsVIX
Spreads vs
German
Italy 1 0 0 0 1 1 -1
Spain -1 1 0 2 1 1 1
Portugal 0 0 0 1 1 1 0
France 1 1 0 0 1 1 0
Explanatory variables outlook 2016
Base Case Scenario Assumptions:
• High markets volatility will probably remain in place in 2016.
• Increased political risks in Spain due to no majority in parliament.
• Stable economic growth in Eurozone around 1.7% in 2016.
• The ECB may cut the deposit rate at its March meeting. Low probability that the ECB will decide to expand the size of
its QE programme in 2016.
• Fiscal position in most countries the same as in 2015. Government debt as a percent of GDP is expected slightly
higher in Spain and France.
• Low inflation environment will continue in 2016 due to drop of oil price.
Taking into account the above mentioned assumptions we estimate that:
• Spain’s spread vs Bund may widen in 2016 (Feb. 1 2016: 119 bps), mainly due to political uncertainty.
• Italy’s sovereign spread (Feb. 1 2016: 108 bps) is estimated to tighten until the year end due to improved economic
outlook.
• Portugal’s 10-year government bond yields spread vs Germany may be in range (Feb. 1 2016: 257 bps), as economic
activity will remain supportive in 2016. In case, markets volatility is higher than in our base case scenario, Portugal will
be more vulnerable than other Eurozone countries.
• France’s spread vs Bund is expected to remain close to current levels (Feb. 1 2016: 32 bps), however, upside risks
may arise during the 2016 due to negative fiscal data outlook.
Appendix: Econometric model
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8 euro area countries (Austria, Belgium, Greece, Italy, Spain, Netherlands, Portugal, France).
10-year period (2005-2015) in monthly frequency.
Balanced long panel with big T (time period), small N (number of countries).
Explanatory variables: first lag of sovereign spreads, vix, total assets of ECB, fiscal balance, government debt,
inflation, industrial production.
Descriptive statistics are presented below.
Appendix: Data
17
Model:
𝑠𝑝𝑟𝑒𝑎𝑑𝑠𝑖𝑡 = 𝑐 + 𝛽1𝑠𝑝𝑟𝑒𝑎𝑑𝑠𝑖𝑡−1 + 𝛽2𝑐𝑝𝑖𝑖𝑡 + 𝛽3log_𝑣𝑖𝑥𝑡 + 𝛽4log_𝑒𝑐𝑏𝑡 + 𝛽5𝑏𝑎𝑙𝑎𝑛𝑐𝑒𝑖𝑡
+𝛽6𝑑𝑒𝑏𝑡𝑖𝑡 + 𝛽7𝑖𝑛𝑑𝑢𝑠𝑡_𝑝𝑟𝑜𝑑𝑖𝑡 + 𝛼𝑖 + 𝜀𝑖𝑡
𝛼𝑖 = country specific effect
𝜀𝑖𝑡 = transitory error term
2SLS process
Fixed effects estimation
Cross section weights which accounts for heteroskedasticity
Account for endogeneity: set of instruments
Appendix: Methodology 1
18
Description of the 2SLS (instrumental variables) process:
First stage:
𝑒𝑛𝑑𝑜𝑔𝑖𝑡 = 𝑑 + 𝛾1𝑠𝑝𝑟𝑒𝑎𝑑𝑠𝑖𝑡 + 𝛾2𝑖𝑛𝑠𝑡𝑟𝑖𝑡 + 𝑢𝑖𝑡
Where: 𝑒𝑛𝑑𝑜𝑔𝑖𝑡 = endogenous variables
𝑖𝑛𝑠𝑡𝑟𝑖𝑡= instrumental variables
The goal of the method is to find a proxy for the endogenous variables that will not be correlated
with the error term.
Second stage:
𝑠𝑝𝑟𝑒𝑎𝑑𝑠𝑖𝑡 = 𝑒𝑛𝑑𝑜𝑔 𝑖𝑡 + 𝛽𝑖𝑠𝑝𝑟𝑒𝑎𝑑𝑠𝑖𝑡
Appendix: Methodology 2
19
Appendix: Results
20
Contact
210-3282791 [email protected]
Panos Remoundos [email protected] Maria Koutouzi [email protected] Ioannis Kouravelos, CFA [email protected] Konstantinos Anathreptaκis [email protected] Niki Konstantopoulou [email protected]
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