Investor perception drives government bond yields
Government bond yields represent the interest a government needs to pay annually in order to borrow money from the market by selling bonds. Sovereign bond yields are based on investor perception of the financial position and the credibility of the government issuing the debt. The higher the riskiness perceived by investors with respect to repayment of their money, the higher the interest rate they expect on the debt. Higher bond yields make it more expensive for governments to borrow money. A ten-year yield above 7% had triggered bailouts for Greece, Portugal, and Ireland.
Government bond yields in the Eurozone have been declining
Government bond yields in the Eurozone have been declining. However, you shouldn’t mistake this for increased investor confidence toward government-owned debt.
Bond yields in the Eurozone have plummeted to record lows for more than a few months. Bond yields move inversely to prices. The decline in yields in the Eurozone has come on the back of healthy investor demand for bonds compared to the jittery European stock markets in the previous year. Popular exchange-traded funds such as the Vanguard FTSE Europe ETF (VGK), the iShares MSCI EMU Index Fund (EZU), the iShares S&P Europe 350 Index Fund (IEV), the Wisdomtree International Hedged Equity Fund (HEDJ), and the SPDR DJ EURO STOXX 50 ETF (FEZ) track European stock markets.
The European Central Bank (the ECB’s) plans push bond yields further down
Another reason for the decline in Eurozone yields was the ongoing expectations of the European Central Bank launching its quantitative easing (or QE) program to boost credit and spending. Measures such as QE provide stimulus by increasing the money supply. Increased credit availability puts downward pressure on yields.
Interestingly, about 25% (EUR 1.2 trillion) of the current Eurozone government bond market is trading with a negative yield. So far this year, the yields on the five-year German government bond, the five-year Finnish government bond, and the seven-year Swiss government bond have slipped into negative territory.
When investors prefer paying to park their funds with the government rather than holding cash, the situation speaks volumes about the financial health of the economy and consumer faith in the currency.
The euro has been depreciating. Is that good or bad for the economy and your investments? Let’s take a look in the next part of this series.