A retrospective look at sovereign bond dynamics in the euro area

This section looks back at sovereign bond dynamics in the euro area over the past two decades, taking stock of both the price and flow dimensions. As regards cross-border flows, the 2008 crisis appears to have provoked, amongst its more immediate effects, investment fund outflows from EU bond markets. The years of the subsequent Great Recession witnessed a mutual retrenchment in the US and the EU from each other's international debt markets. At the same time, debt flow dynamics within the euro area largely reversed when compared with the pre-crisis period, with the countries more severely affected by the crisis experiencing outflows, as less vulnerable countries pulled back their cross-border debt investments. As regards bond prices, the crisis period was characterised by highly asymmetric dynamics across groups of euro area countries which – according to model-based results – appear to have been largely driven by differences in debt ratios, bouts of illiquidity and divergent market sensitivities, the latter being suggestive of flight-to-safety phenomena, among other factors. Panel model-based evidence is also suggestive of instances of price misalignment from fundamentals, in different moments and countries. Unconventional monetary policy is seen to have played an important role in stabilising sovereign debt markets since 2012. Overall, an institutional setup that can eliminate bouts of illiquidity, prevent market sensitivities from reacting in a divergent manner to yield drivers and remove redenomination risk could deliver significant stability benefits for the euro area.