Spain Borrowing at German Yields? It’s Possible, Thanks to U.S.

Europe’s peripheral countries are on their way to catching up with Germany in the bond market for the first time since 2010. While Mario Draghi is winning the plaudits, there’s also the U.S. economy to thank.

Faster growth in the U.S. correlates with economies in the rest of the world accelerating too, with Spain and Italy being the biggest beneficiaries, according to Athanasios Vamvakidis, a strategist at Bank of America Merrill Lynch in London. That suggests the U.S., where growth is forecast to rise to 3 percent in 2015 and 2016, may help the bedridden euro zone regain its health over time.

“U.S. growth has positive spillovers in the rest of the world and affects growth in other countries,” Vamvakidis said in a note yesterday. “For the euro zone in particular, we find that growth in the U.S. supports intra-euro economic convergence.”

According to Vamvakidis, 1 percent faster growth in the world’s biggest economy gives Spain a 1.31 percent boost while Italy will enjoy a 0.92 percent lift. Germany, Europe’s export engine, has to make do with 0.13 percent, he estimates.

U.S. growth rates need to make a difference, given that the International Monetary Fund says that after shrinking 1.2 percent last year, the Spanish economy will expand 0.9 percent this year and 1 percent next. The Washington-based Fund predicts similar figures for Italy.

Easing Mode

Those rates, combined with the risk of deflation and near-record unemployment across the region, are keeping European Central Bank President Draghi in easing mode and suggest there’s still room for Italian and Spanish bond yields to converge with Germany’s.

The extra yield investors demand to own Spanish and Italian 10-year notes rather than German bunds has declined 0.84 percentage point in the past six months.

Both countries are now borrowing at a cost of about 1.65 percentage points above German yields. In the case of Italy, that’s more than seven times the average in the four years before the global financial crisis began in 2008, while Spain paid an average premium of 3 basis points in the four years to January, 2008.

That means there’s still room for relative costs to fall, an incentive for investors to keep piling in. What’s more, Greece, shut out of debt markets since 2010, is preparing a comeback today, with a 3 billion-euro ($4.15 billion) sale of five-year notes via banks, increased from 2.5 billion euros.

One note of caution. The last time Europe’s periphery was able to borrow at German rates, the spree ended with international bailouts, enforced austerity and investors losing money. Those who forget history are doomed to repeat it.

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