What Is The BTP Bund Spread?
A spread in this scenario simply refers to the difference between two countries bonds, in the case of the BTP/Bund spread it’s the difference in the yield between the Italian 10-year bond yield and the German 10-year bond yield.
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We have a quick question from Marlo asking what exactly is the BTP/Bund spread and what is it’s relationship to the Euro. Thanks for the question Marlo.
So, as you know, a spread in this scenario simply refers to the difference between two countries bonds, in the case of the BTP/Bund spread it’s the difference in the yield between the Italian 10-year bond yield and the German 10-year bond yield.
So, if the yields on Italian 10-years is sitting at 2% and the yield on 10-year bunds is sitting at 1%, the BTP/Bund spread will be 1%.
Why is the spread significant and what is it’s impact on the EUR? When you look at the country composition of the Eurozone, Germany is by far one of the safest in terms of economic health and well being and is considered to be one of the most stable countries in the EU economically and politically.
Thus, when it comes to bonds and investing in bonds, one of the safest bonds you can buy in the Eurozone is German Bunds. So, when we compare that with a country like Italy which has had debt issues for quite some time, the market is essentially using the spread between the two yields to measure the risk of buying Italian bonds over German bunds.
Remember that bonds of governments of companies that has a higher possibility of default has to pay higher yields to attract investors to buy them. That’s why countries like Italy will sell dollar-denominated bonds instead of Euro denominated bonds, because even thought it would be much cheaper for them to issue new debt in Euros, they issue them in the Dollar in order to boost the attractiveness of the bonds.
Thus, when things go bad in Italy and market worry about rising default risks you’ll see that Italian yields will rise, just like yields would rise for an emerging market economy’s bond yields when their risk of default increases.
So, coming back to the BTP/Bund spread, by comparing the difference between a riskier bond from Italy and a stable bond from Germany, the spread acts as a risk premium on the Euro. So, when uncertainty increases in the Eurozone and more specifically in Italy you’ll see a rise in the spread, which from a risk point of view should have an inverse reaction on the Euro.
Thus, when we had the recent political uncertainty from Italy starting to ramp up we saw the spread moving higher by quite a bit, and was one of the reasons for anticipating some EUR weakness on the back of that.
So, going to the charts that means whenever the spread moves higher that should see pressure on the Euro and whenever the spread is moving lower that should be supportive for the EUR, but of course like any correlation it’s not perfect and always keep in mind that correlation does not necessarily mean causation, which means that if the spread moves up it does not always lead to EUR weakness and every move lower does not always lead to EUR strength.
There can always be other idiosyncratic drivers moving the Euro at any given time which might have nothing to do with the spread at all. I hope that helps Marlo, and other questions don’t hesitate to let us know.
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There’s a link below were you can learn more about it
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----
We interpret and explain price moves in real-time, 24 hours a day. Our team of analysts produce text, video and audio commentary.
You understand the markets and trade with confidence. Learn more at our website here: https://financialsource.co
-----
We have a quick question from Marlo asking what exactly is the BTP/Bund spread and what is it’s relationship to the Euro. Thanks for the question Marlo.
So, as you know, a spread in this scenario simply refers to the difference between two countries bonds, in the case of the BTP/Bund spread it’s the difference in the yield between the Italian 10-year bond yield and the German 10-year bond yield.
So, if the yields on Italian 10-years is sitting at 2% and the yield on 10-year bunds is sitting at 1%, the BTP/Bund spread will be 1%.
Why is the spread significant and what is it’s impact on the EUR? When you look at the country composition of the Eurozone, Germany is by far one of the safest in terms of economic health and well being and is considered to be one of the most stable countries in the EU economically and politically.
Thus, when it comes to bonds and investing in bonds, one of the safest bonds you can buy in the Eurozone is German Bunds. So, when we compare that with a country like Italy which has had debt issues for quite some time, the market is essentially using the spread between the two yields to measure the risk of buying Italian bonds over German bunds.
Remember that bonds of governments of companies that has a higher possibility of default has to pay higher yields to attract investors to buy them. That’s why countries like Italy will sell dollar-denominated bonds instead of Euro denominated bonds, because even thought it would be much cheaper for them to issue new debt in Euros, they issue them in the Dollar in order to boost the attractiveness of the bonds.
Thus, when things go bad in Italy and market worry about rising default risks you’ll see that Italian yields will rise, just like yields would rise for an emerging market economy’s bond yields when their risk of default increases.
So, coming back to the BTP/Bund spread, by comparing the difference between a riskier bond from Italy and a stable bond from Germany, the spread acts as a risk premium on the Euro. So, when uncertainty increases in the Eurozone and more specifically in Italy you’ll see a rise in the spread, which from a risk point of view should have an inverse reaction on the Euro.
Thus, when we had the recent political uncertainty from Italy starting to ramp up we saw the spread moving higher by quite a bit, and was one of the reasons for anticipating some EUR weakness on the back of that.
So, going to the charts that means whenever the spread moves higher that should see pressure on the Euro and whenever the spread is moving lower that should be supportive for the EUR, but of course like any correlation it’s not perfect and always keep in mind that correlation does not necessarily mean causation, which means that if the spread moves up it does not always lead to EUR weakness and every move lower does not always lead to EUR strength.
There can always be other idiosyncratic drivers moving the Euro at any given time which might have nothing to do with the spread at all. I hope that helps Marlo, and other questions don’t hesitate to let us know.
-----
If you find this content helpful, you’ll love Financial Source.
There’s a link below were you can learn more about it
https://financialsource.co
