The so-called spread it is a number that indicates the current yield difference (i.e. calculated in real time) between two bonds reference, in particular two government bonds with the same duration. In the’European Unionare generally taken into consideration i Italian government bonds (BTP) and the German ones (called Bund): the difference between the two returns is called the spread and is also an indicator of the economic health of the Eurozone. We talk about “yield” because, once issued, securities are bought and sold every day at variable prices, causing continuous changes in their yield. The degree of risk associated with a security is closely linked to the market confidence in the economy of the State that issued it. In other words, if investors believe that a state may have difficulty repaying its debt, the state will be forced to offer higher interest rates to attract capital through the sale of securities. As a result, generally a higher return indicates greater perceived risk. In summary, the spread represents investors’ perception of the economic stability of one state compared to another. An increase in the spread tends to indicate greater distrust and a higher perception of risk in lending money to a state, while a decrease signals greater confidence and a lower perceived risk.
What is the BTP-Bund Spread?
When we hear about spreadwe generally refer to a very precise difference, that between the performance of a Italian BTP (a bond issued by the Italian state) and a German Bund (a bond issued by the German state) with the same maturity. By convention, the maturity is set at 10 years. The Italian BTP it has historically had a higher yield than the Bund, due to the perception of greater risk associated with Italy’s economy.
But why the BTP and the Bund?
THE’Italy it has a more vulnerable economy than Germany, with a higher level of public debt and less stable economic growth. On the contrary, the Germany is considered the economic powerhouse of the eurozone and its government bonds are seen as the safest, with the lowest risk of default among the various European states (i.e. investors believe that compared to other European states it is easier to repay its debts), thanks to its financial solidity.
How is the spread calculated?
The spread is calculated by doing a simple subtraction between the current yield of a government bond (e.g. BTP) and the current yield of another (e.g. Bund), both with the same maturity. The result is expressed in basis points. For example, if the yield on the BTP is 3% and that on the Bund is 2%, the spread will be 1 percentage point, or 100 basis points.
Taking December 22, 2024 as an example, the returns were:
10 year BTP: 3.44%
10 year Bund: 2.28%
So the spread between the two securities at that time was approximately 1.16%, i.e. 116 basis points.
What determines the increase in the spread?
When we say that the spread increases we mean that the yield of one of the two government bonds has increased compared to the other (or vice versa), thus increasing the distance between the two. This rising condition occurs especially during times when governments face challenges financial crisesor you are in a time of high inflation or there are some geopolitical tensions. These are some of the causes that often lead to the spread rising, as investors demand higher returns to compensate for the higher risk of investments.
If instead it is spread decreasesit means that i risks of the two countries become closer, i.e. Italy becomes more secure (if the BTP yield falls) or Germany is seen as less secure (if the Bund yield increases). Since it is a difference, it is, in fact, also possible that the performance of one country has not necessarily increased, but that perhaps the performance of the other has decreased.
