In 1996, the convergence rally on high-yielding European government bonds was one big, premature Emu party, staged in the belief that all the governments that said they'd be ready for first-round entry to the eu's single-currency system would be. Market enthusiasm was based on taking note of contender countries' political commitment to European economic and monetary union rather than their economic fundamentals. This year bullishness will be replaced by a more cautious approach, as the markets become increasingly volatile.
In the course of the year the Bundesbank will probably have to raise interest rates in response to rapid German economic recovery. This could have a catastrophic effect on the high-yield bond markets. Already some investors that bet heavily on convergence last year are reversing their positions. Kurt Schibli, fixed-income manager at Schroder Investment Management, says his firm's portfolio has moved from being overweight to neutral on the so-called periphery countries, such as Spain and Sweden, and from overweight to underweight on Italy. "Convergence in periphery country markets will not withstand conditions of high German interest rates," he says.
So far investors have ignored another danger: blatant fiddling of the books by Belgium, France and Italy to make their economies meet the Maastricht treaty criteria.