Euro area sovereign bond yields during the Covid-19 pandemic: What do they tell us?

Sovereign bonds are very important capital market instruments. Their effective supply and creditworthiness results in a well-functioning and liquid secondary market with high levels of trading activity and narrow bid-ask spreads. Government bonds represent a key reserve asset for central banks and a very popular investment asset for retail and institutional investors. Bond yields are determined by investor expectations, and in particular, by economic expectations about future growth prospects. While there are many factors that can influence the yield on a specific bond, one of the most important is the behaviour of the sovereign yield curve. Examining the slope of the sovereign bond yield curve before and during the Covid-19 pandemic can help us to draw conclusions with regard to future growth prospects in the euro area. A first analysis of the euro area sovereign bond yield shows that a recession in the euro area is unlikely to occur in the near future, but instead there is an expectation that the eurozone economy will exhibit higher growth rates over the coming months. However, this would largely depend on the vaccines’ effectiveness to bring the pandemic to an end.

The study of sovereign bond yields is very crucial from a capital markets perspective, as it affects investors’ returns and portfolio rebalancing strategies. As the return on a bond portfolio is linked to movements in the yield curve, any changes in the latter will affect the mark-to-market return of the portfolio. The yield curve is a visual illustration of the term structure of interest rates. It shows the relationship among yields of bonds with similar credit risk characteristics across the maturity spectrum. 

Vassilios Papavassiliou is Assistant Professor of Finance, University College Dublin, UCD Michael Smurfit Graduate Business School, Ireland