Investors Expectations About The Government Bonds

Probably the biggest challenge is being faced by euro-zone government bond investors. The key problem relates to these investors’ expectations about the behavior of government bonds. Managers of government bond funds are among the most conservative in their risk appetite. Before the crisis in Europe, it was believed that euro-zone government bonds were, like U.S. Treasurys and U.K. gilts, free of default risk. This was backed up by zero-risk weightings for bank capital purposes from regulators. They were highly rated, with most euro-zone countries sporting a triple-A or double-A ranking. Many euro-zone government bond investors have realized to their horror that they no longer own traditional government bonds, but instead hold bonds with credit risk. Investors, who might be willing to take credit risk aren’t willing to buy a government bonds either. In some cases this is because the terms of their mandate don’t permit them to buy government bonds; in others, it is because it has turned out to be hard to analyze government bonds, because of both the extent of contingent liabilities and the role played by politicians. Corporate balance sheets are a simpler affair. And even for those government bonds where default is massively unlikely and ratings remain high, price volatility has increased and liquidity fallen, tarnishing the safe-haven status of this debt. This has started to affect even France: Up until July, yield spreads between French and German 10-year bonds tended to move in a daily range of plus/minus 0.05 percentage point; since then, this has tripled to around plus/minus 0.15 percentage point, Citigroup notes. Europe has taken aim at the symptoms of the problem. But efforts to recapitalize the banks are meant to enable them to cope with theoretical losses on government bonds, not to reduce the risk of losses occurring. Similarly, plans to increase the firepower of the European Financial Stability Facility may fall short of encouraging government bond investors to re-engage with Italian and Spanish bond markets.