Europe's Emerging Heart: Spain Takes Center Stage

In the realm of European finance, Spain's sovereign bond market has been making waves in 2024. With over 75% of its annual issuance program completed, an impressive €135 billion has been raised, marking a significant increase in appetite for Spanish bonds.

Two key factors continue to explain the premium over French debt: liquidity and the Spanish economy's sensitivity to cyclical fluctuations. Despite these challenges, the performance of Spanish government bonds has been influenced by Spain’s improving economic fundamentals.

The country's stronger-than-expected economic growth, coupled with the narrowing of credit spreads, is a testament to increasing investor confidence in Spain’s fiscal sustainability. However, the sustainability of Spanish bonds depends on maintaining fiscal discipline amid broader EU economic challenges and global uncertainties.

Spanish bond spreads have been narrowing relative to other countries like Italy, reflecting improved credit perceptions. Yet, the overall sustainability also hinges on managing government deficits and debt levels responsibly.

Since the end of 2021, Spain's public finance indicators have improved much more rapidly than in other eurozone countries, particularly compared to France. This rapid improvement has led Spain, rated A+, to trade at levels very close to France, rated AA-, a situation unprecedented since 2008.

Spain is likely to benefit from improvements in sovereign rating revisions from Moody's, DBRS, and Scope. Since 2017, Spain has seen the most significant relative improvement in sovereign yield spreads vis-à-vis Germany.

During periods of widening sovereign spreads, Spain is becoming less sensitive to risk aversion events. The yield on the 10-year Bono has approached that of the OAT, hovering around +10 basis points since the announcement of early legislative elections in France.

The trajectory of Spanish debt appears to be better controlled, at least in the medium term and in the absence of a crisis, than that of French debt. This control is evident in the Bono-Bund 10Y spread, which has tightened by about 40 basis points since early 2017, while the OAT-Bund 10Y spread has widened by approximately 10 basis points.

The Spanish economy, while less diversified, has shown resilience in the face of cyclical fluctuations. The GDP recovery in Spain has been impressive, having increased by around 3% over the last few quarters, with prospects remaining around 2%, well above those of other European countries.

This resurgence in the Spanish economy is driven by a rebound in household consumption, investment, dynamic exports, and an acceleration in tourism activity. Spain has also benefited from a shift towards closer tourist destinations and enhanced infrastructure services since the end of the health crisis.

Non-resident investors have shown a rising subscription to Spanish sovereign bonds, contributing to the market's growth. Spanish rates are converging towards French rates, starting from a less favorable position to end up very close to each other.

Jesus Castillo, an economist specializing in Southern Europe and the Euro Area, notes that this trend is a significant development in the European bond market. As Spain continues to navigate its economic growth and fiscal sustainability, the world watches with interest to see how this story unfolds.