Quantitative Easings Led to Spread Compression in European Bonds



The ECB’s launch of its one trillion euro rescue plan this week has implications for investors everywhere. Jeffrey Rosenberg dissects two critical comments Mario Draghi made after the announcement.

The European Central Bank on Thursday, January 22, delivered­ basically what the market expected for QE (quantitative easing): 60 billion euros of purchases per month directed at investment-grade-rated government and agency debt and with a total size, considering the contemplated end date by September 2016, of around one trillion euros. The modest decline in the euro and further declines in European bond yields, along with compression between peripheral and core bonds, all reflect the success of a QE announcement in line with market expectations.

spread compression in European bonds

Article continues below advertisement

Market Realist – The announcement of QE in Europe led to credit spread compression in European bonds.

The QE program started in Europe on March 9. While markets are hopeful that this will help revive the European economy, many analysts feel that QE alone will not help the economy. This series explains why.

The graph above shows the spread between the German ten-year government bond yield—which is considered safe—and the Spanish ten-year government bond yield. It also shows the spread between the former and the Italian government bond yield. Both Spanish and Italian government bonds are considered to be less safe than German bunds.

The spread is shown in basis points. A hundred basis points make up 1%. The ECB (European Central Bank) announced the launch of the European QE program on January 22. The spread decreased from 111 and 116 basis points on January 21 to 104 and 110 basis points for Spanish and Italian bonds, respectively.

The European version of QE made investors hopeful of an economic revival in Europe (EZU)(VGK), which caused the spread to compress. Remember, bonds with higher credit risk—like Spanish and Italian government bonds—outperform safer bonds—like German bunds—when the economy is improving or when certain steps like QE are taken, which raises hopes for an improvement in the economy.

Most developed markets (EFA)(VEA), including Japan (EWJ) and the US (SPY), have seen improvements in their respective economies after the implementation of QE. However, Europe could be an exception to this trend.


More From Market Realist