Spreads on euro-denominated sovereigns issued by new members of the European Union are so tight that some market watchers are questioning whether there will be any juice left when these countries actually join the euro. Previously, a significant disparity in spreads existed between the debt of E.U. members in the euro and those not in the euro, offering significant room for convergence once exchange rate risk was eliminated upon adoption of the euro.
The early tightening is "in part due to the convergence trade on Portuguese and Greek Eurobonds that worked so successfully when those two countries joined the euro in 2000 and 2001," observed Dimitri Toseland, head of frequent borrowers with a focus on sovereigns, agencies and supra-nationals at Bank of America in London.
Chris Tuffey, head of the investment-grade syndicate at Credit Suisse First Boston, agreed that spreads on newly issued accession country Eurobonds are tighter than in the past but said they are not too tight relative to the rest of the market. Sovereigns are now seeing spread convergence when a country joins the E.U., rather than when it joins the single currency, on the basis that to join the E.U. a country has to demonstrate a certain level of institutional stability and gains access to the massive E.U. development budget.
Rather than getting a pick-up, there could even be a backlash in spreads by the time the countries adopt the euro. Portugal's debt, for example, was trading at about 300bps over comparable German Bunds before it joined the EMU in 2000. Yet the Republic of Cyprus's recent Eurobond was priced at just 23bps over comparable German government debt. And the Czech Republic's Eurobond offering, which was priced at 12bps over mid-swaps last month, came only 3bps wider than comparable Greek debt and 5bps wider than comparable Italian debt. The convergence has evaporated even as these new E.U. members are years away from adopting the euro; Cyprus has started its two year membership of the exchange rate mechanism, a pre-requisite for joining the euro, but the Czechs do not yet qualify and are therefore even farther off.
