With German shares at a negative yield, does the spread make sense?

Andrea Muratore

On a daily basis, in economic and financial press releases, the spread between Italian bonds (BTPs) and German Bunds is duly reported as the key benchmark for understanding how reliable Italy’s economic policy is. Current reports state that an increase in spread automatically points to an interest rate rise that Italy must pay on its government securities and, concurrently, a decline in national market confidence.

Nothing could be further from the truth. The spread is nothing more than a gap between two variable rates of return, namely the BTP and Bund, expressed in “basis points” rather than percentages. For example, if on a given day an Italian bond makes 2.5%, and its German counterpart makes 0.5%, the difference (2%) is expressed indicating a spread of 200 basis points. From the hysteria about the spread that broke out when Berlusconi’s government collapsed in 2011, to the present day, one basic fact is rarely explained: that the spread can of course vary, even if it’s German Bund rather than the Italian bond that does so.

In recent months, the German Bund has slipped into profoundly negative territory and Berlin has failed to implement strategies to lift its public debt out of the quagmire. Germany’s policies of deficit containment and economic stagnation have progressively rendered the Bund illiquid, leading some experts and stakeholders to provocatively imagine a future where it will find itself completely excluded from the financial markets. Moreover, from the end of May to the present day, the share value has deeply declined into negative territory. If on 30 May the Bund yielded just under -0.15%, it has now fallen to around -0.67%. This changes every conversation that has taken place about the, somewhat dubious, credibility of the spread as an effective value for reporting developments in the Italian economy. Speaking of a 200-spread is different depending on whether the yield on the Italian bond is around 3% or, as is the case these days, a much smaller 1.2-1.3%.

Reporting the spread dogmatically and persisting in past mistakes is misleading when not combining it with the 10-year BTP’s actual yield, and allowing for national and international economic factors, with the sole value of the spread only presenting one side. It means continually bringing poor economic information to the fore, as well as immediately aligning any variations with solely domestic political developments. For example the BTP’s quarterly yield curve shows a substantial halving in its value during the summer months, aside from a very brief “flare-up” on the day following the initiation of the government crisis, which immediately subsided. The share value fell, as mentioned before, from over 2.5% to just over 1%.

The decrease is dictated by global economic conditions linked, above all, to the central banks returning to “permanent quantitative easing”. This will cause bond values to plateau and, as feared, a collapse in the future financial environment due to stagnant conditions in Western real economies. Only talking about the spread means completely disregarding both the stagnating German side, indicated by a drop in share value, and the effects on bond value caused by major developments in the international economy. They are simplified and trivialised by economic information which, with limited exceptions (we recommend, in particular, Vito Lops of Italian business newspaper Sole 24 Ore and Mauro Bottarelli of Il Sussidiario for the coherence of their work), casually reiterates few concepts, from the tariff war to eurozone government debts, without giving them the necessary in-depth analysis.