Can somebody explain what kind of information one can get from observing government bond yields in different countries? Can they be compared? For example, the US and Germany’s 10-year yields are 2.9 and and 1.8, respectively. It follows that the YTM for 10-year bond in the US is greater than it is in Germany. Is there any other conclusion one can make? Are these numbers comparable?
For large liquid markets like US treasurys and German bunds, analysts will often assume that the real interest rates are identical and that the differences in yields reflect differing inflation expectations in the US vs Germany. So under these common assumptions, the expectation built into those bond yields is that the US inflation rate will be about 1.1% larger than Germany’s.
That is an assumption, however. Also the assumption is that the difference solely reflects inflation expectations (which in addition, doesn’t necessarily mean that that’s what the inflation difference will be).
Another thing that can change this is supply and demand for the bonds. Demand for German Bunds and US Treasurys is large enough that the inflation expectations assumptions are reasonable, but if the Euro crisis went away tomorrow, demand for Bunds would fall, and people would start buying more French, Italian, Spanish, and Greek bonds, which would ultimately push up German rates independently of inflation.
In smaller and less liquid markets, the difference in rates will reflect inflation expectations, but supply and demand factors, such as the need for bonds in local currencies. If you need to hedge a liability in your own currency, you may need to use a bond in your own currency, or else take on the risk of currency rates moving against you, and so this is different than money running around seeking a higher yield.
The difference can also reflect expectations of sovereign risk (the likelihood that the government will either choose not to or simply be unable to make good on its payments). Usually a country that issues debt in its own currency does not have much sovereign risk, but the Europeans don’t have that option (no country has the power to print up more Euros on its own), and the US Congress seems to enjoy threatening not to pay as a political bargaining chip. So there is sovereign risk going on as well.
Thank you for your answer! It seems that there are many factors that can give this difference in yields. Is this right to say that even if the yields are equal, it does not mean that investors should be indifferent between the bonds?
There’s pretty much always a risk dimension and a return dimension. If the after-inflation expected yields are identical, then choose the bond with the least risk. If there is a difference in yield, you have to decide if the increment in yield is worth the increment in risk, unless you are lucky enough to discover higher yield with lower risk (which should immediately have your mind asking “what is not right here, and why”)
What I have observed is the following:
In Euro currency, the benchmark is German Bunds, and it is what really sets the tone, i.e. it is responsible for much of the movements on the markets.
If the markets have been rather stable since 2 weeks (I haven’t really checked figures since then), the spread of a comparable French 10Y note should be around 55 points, and the swap spread should be around 25 points (although it’s been narrowing).
These spreads have been rather fixed for the last months,while the markets have been volative, which reflects that the movements are coming from the benchmark.
As Bchad mentioned, the change in supply/demand and its effect on yield is complicated. If say, swap spreads diminish, it could be that banks perceive other banks as less risky. Or that banks have more funds to loan to other banks. Or that banks have less need to borrow from other banks. Or, most likely, as with many things, a complicated combination of these factors and more.