Spreads Between Countries

Sovereign spreads: measuring relative risk
The spread between the yields of government bonds from different countries reflects differences in credit risk, expectations of monetary policy, and market dynamics. Monitoring spreads is a key tool for a global fixed income investor.

Key spreads and their interpretation

Spread	Formula	What it shows	Typical range
BTP-Bund	Italy 10Y - Germany 10Y	EU periphery risk, Italy political risk	100–300 bp
Spain-Bund	Spain 10Y - Germany 10Y	Spain’s credit risk	60–150 bp
OAT-Bund	France 10Y - Germany 10Y	Relative quality of France	30–80 bp
US-Bund	US 10Y - Germany 10Y	Difference in Fed & ECB policy	100–250 bp
Gilt-Bund	UK 10Y - Germany 10Y	Brexit premium, UK macro	80–200 bp

BTP-Bund Spread Dynamics (History)

Period	Spread (bp)	Event
2007	20–70	Pre-crisis, eurozone convergence
2011–2012	550+	European sovereign debt crisis
2014–2019	100–150	“Whatever it takes” (Draghi)
2020 (COVID)	280	Short-term stress
2022	250	Rate hikes, Italian politics
2023	180–200	Relative stability

Factors influencing spreads

Fiscal policy — budget deficit, debt-to-GDP level
Political risk — elections, populism, relations with the EU
Economic growth — ability to service debt
ECB actions — bond purchases, TPI (Transmission Protection Instrument)
Global risk appetite — flight to quality during crises

Spread trading strategies

Strategy	Position	When to apply	Risks
Convergence	Long periphery, Short core	Spreads have widened excessively, expectation of stabilization	Further widening
Divergence	Short periphery, Long core	Growing risks, pre-crisis	Central bank intervention
Carry trade	Long high-yielders, hedge duration	Stable environment	Spread widening
Relative value	Long/Short pairs within region	Pricing distortions	Convergence timing

Example of a Convergence Trade (2020)

March 2020, COVID crisis:
BTP-Bund spread: widened from 140 to 280 bp
Idea: ECB will announce support, spread will tighten
Position: Long Italy 10Y, Short Germany 10Y (duration-neutral)
Result: After PEPP, spread narrowed to 150 bp = +130 bp profit

US-Germany spread and FX implications

The US-Bund spread influences EUR/USD:
Widening spread → capital flows into USD → USD strengthens
Narrowing spread → relative attractiveness of EUR increases
Important: the spread must account for currency hedging cost

Currency-Hedged Yield Analysis

Position	Nominal Yield	FX Hedge Cost	Hedged Yield
US 10Y (for EUR investor)	4.5%	-2.0%	2.5%
Germany 10Y	2.5%	0%	2.5%
UK 10Y (for EUR investor)	4.3%	-1.5%	2.8%

After hedging currency risk, yields often even out!