This year has been historic for European markets. Fixed income markets expect Emu to start on time because of impressive political will to make it happen even in an adverse economic environment. Lower global bond yields have supported this process, withstanding a temporary setback in the US. Since the beginning of 1996, three-month forward rates after 1999 have fully converged between Germany, France and Benelux. Long bond yields in the core converged in spring, with currencies gaining stability from summer. Spreads between hopefuls like Italy and Spain have also been narrowing sharply through the year.
Support for Emu is growing given convergence trades in the periphery and lower bond yields in Germany. Ten-year Bund yields of 5.7% and Italian bond spreads over Germany of 150 basis points are only a matter of time. There is even a chance to test the 1993 lows in the Bund cash market.
The markets seem to be affected by the political resolve to make Emu happen on time more than by progress on economic convergence. This is reflected in their willingness to forgive the budgetary accounting tricks of various countries, expecting that the stability pact inititated by the Bundesbank will help to deliver long-term fiscal restraint on the Maastricht lines.
