5/25/2018

Chart of the week: A tale of two economies in the Eurozone periphery


Bond markets have learned to differentiate between different countries within the Eurozone. Just look at the diverging fortunes of Spain and Italy.
Five years ago, many people barely differentiated between various countries of the Eurozone periphery. Cynical commentators used an offensive acronym, lumping Portugal, Italy, Ireland, Greece and Spain together. Recent developments demonstrate that markets do differentiate, and are honoring fundamental improvements.
In our "Chart of the Week", we take a look at the yield differential (spread) between Spanish and Italian 10-year sovereign bonds. Back in 2013, yields on Spanish bonds were trading up to one percentage point above their Italian counterpart, implying that investors demanded a higher risk premium on Spanish debt. Comparing the economic performance of the two countries since then, we find that Spain has managed to grow three times as fast as Italy: According to International Monetary Fund (IMF) data, Italian GDP grew by 3.4% in total between 2013 and 2017, or 0.8% per year, while Spain’s GDP was 11.6% higher in 2017 compared to 2013 (that’s an annual rate of 2.8%). Spain brought down its budget deficit by 4.5 percentage points, the equivalent improvement in Italy amounted to 1.4 percentage points. Spain’s outperformance is reflected by market prices of bonds, and since 2017, Spanish yields have been trading below their Italian counterparts. We have recently started to treat Spain as a semi-core country, and no more as a part of the periphery.
To sum it up, markets reward positive economic development. And the reaction on recent political developments in Italy is a sign that financial markets feel uneasy about the course in Rome.

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