The divergence in performance of different European bonds

Sovereign bonds are generally thought of as safe investments, unless the country issuing the bonds happens to be at risk of failing to repay its debts.

This explains the divergence in performance of different European bonds since the European debt crisis began earlier this year.

German bond yields have recently been hitting 10-year lows after months of strong demand stoked by economic concerns related to the debt situation.

Investors may be worried about contagion from debt-laden countries such as Greece and Portugal affecting the German economy, but there is no expectation that Germany will default on repayments anytime soon.

The yield on Germany’s benchmark bond, the 10-year bund*, now sits at 2.46%, compared with about 10% for a Greek 10-year bond. Yields fall as bond prices rise.

The widening of the ‘spread’ (the difference) between the German bond yields and Greece’s has been one of the main themes in the European bond markets during the debt crisis. Whenever the crisis intensified, investors ran a mile from Greek bonds, worried that the country might default on debts, but German bonds rose as investors sought a haven from the turmoil.

French and UK bond yields are almost as low as Germany’s, while those of Greece’s fellow PIIGS, Portugal, Italy, Ireland and Spain sit somewhere in the middle between the two extremes.

The PIIGS have been hit by downgrades from the credit rating agencies, which has had the effect of pushing down bond prices and increasing bond yields.

While countries such as the UK and Germany have seen their bonds rise amid safe haven investing, they are not completely free of debt worries.

The UK in particular, under its new coalition government, has begun addressing the deficit accumulated during the economic crisis, helping to reassure the market over the reliability of its bonds and thus pushing up prices.

*Bunds are German Bonds in Euro, issued by the German Government