Monday, 23 June 2014

UK and Spain bond yields

Check out this table of 10-year gilt yields for various European countries... (Source)

Germany is paying 1.35% to service its debt, as befits the powerhouse of Europe. France 1.79% because they don't have a massive debt like we do. Greece (5.86%) and Portugal (3.51%) are paying a premium for being risky - not currency risk, they all borrow in euros - but default risk.

The UK is paying 2.73% and Spain 2.72%, practically identical. That's a bit surprising. Are we really equal in the default risk? The Spanish economy is supposed to be flat-lining.

Well, let's have a look at the cost of insuring sovereign debt against default. The so-called credit-default-swap (CDS) market. Here is the cost in percent of insuring debt for 5 years... (Source)

So the UK is actually the cheapest to insure. According to the markets we are the least likely to default on payments. Spain is more that three times as risky as the UK. Even Germany is just sliver more likely to default than the UK.

To square our low default risk with our (relatively) high cost of borrowing we can only assume that the markets are pricing in a fall in the value of sterling. According to the markets, if you buy UK bonds you risk losing money, not because of default, but because of a fall in the value of the pound vs the euro.

Maybe it's time to buy something European.

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