(Bloomberg) -- A key measure of bond market risk in Europe has fallen to the lowest in a decade as the scarcity of high-quality securities that plagued the region’s money markets for years continues to dissipate.
The spread between 10-year German interest-rate swaps and equivalent bond yields has narrowed to 23 basis points, the tightest level since 2014. The latest leg of the move followed news on Friday that Germany, the region’s most credit-worthy borrower, plans to sell more debt next year.
The gap typically indicates how expensive it is for investors to hedge their government bond holdings. It has been tightening over the past year as the European Central Bank reduces its balance sheet, increasing the amount debt available in the market.
Interest-rate swaps are usually higher-yielding than bonds because the counterparty in the transaction is a financial institution, not a government. An unusually large gap tends to points to underlying stress. In 2022, the market faced a severe shortage of those securities, which caused the swap spread to climb above 110 basis points.
George Cole, a senior strategist at Goldman Sachs Group Inc., said the spread should gradually tighten further as the ECB will continue with its quantitative tightening program for some time and Germany isn’t seen reducing the supply of bonds.
Germany will increase net new borrowing next year by about €5 billion ($5.5 billion), taking advantage of a mechanism enshrined in the constitution that allows for additional new debt in times of economic weakness, according to people familiar with the plans.
“The path for Bund spreads will hinge on whether the flows of debt supply are manageable enough for the market to digest,” Cole wrote in a note.
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