To be sure, the gap between the yields on Bunds -- as German federal bonds are known -- and the securities issued by all other euro zone countries has narrowed over the past few years. In part, that's because investors hurt by slumping equity prices have snapped up just about any European government securities they can get their hands on. That has driven up prices and forced down yields.
Spain and other once-weak members of the European Union also benefited from the arrival of the single currency in 1999, which did away with exchange-rate risk in the euro zone. As a result, investors that in the past would have stuck to Bunds are far more willing to buy securities from nations such as Ireland, Portugal, and Greece. "We've seen a big increase in cross-border investment in most markets," says Gianluca Garbi, CEO of MTS Group, the largest electronic market for the trading of fixed-income securities in Europe.
But no country has seen the allure of its bonds increase more than Spain. "Investors increasingly consider Spain a core European country along with Germany or France," says Steven Major, a bond market specialist at HSBC Bank PLC in London.
Just a few years ago, most fixed-income traders would have scoffed at the notion that Spanish bonds could ever have the same appeal for investors as German paper, long the gold standard in Europe's fixed-income market. In the mid-1990s, Spanish bonds were considered such a bad bet that yields topped 11%. Even after the euro was launched, Spanish yields were 10 or more basis points higher. "Investors didn't take Spain seriously," says Job Piet, a fixed income analyst at Rabobank in Utrecht, the Netherlands. "They thought they could never be sure what it would do with its budget."
Not now. Since 1999, Madrid has eliminated its budget deficit, while Berlin's overrun has swollen beyond the 3% of gross domestic product allowed under the EU Growth & Stability Pact. "Spain is a fiscal paragon compared to Germany," says Ray Attrill, European Research Director at 4CAST, a provider of financial market analysis.
Balancing the budget has allowed Spain to slash the amount it borrows. Madrid bought back $3.23 billion of its debt in 2002 and plans to take twice that much off the market this year. Germany, by contrast, pumped out $6.5 billion more bonds than originally planned last year. So the laws of supply and demand are driving up the price of Spanish debt.
At the same time, the dynamic Spanish economy has for a decade performed better than most in the euro zone. Spain recorded growth of 2% last year, while sluggish Germany barely expanded at all. Impressed by Spain's overall performance, rating agency Moody's Investors Service upgraded it to AAA status in December, 2001. By contrast, there have been repeated rumors that Germany could soon lose its top rating.
The Spanish Treasury's management prowess has added to the charm of Spanish bonds. "Five or so years ago, they were much less sophisticated," says a senior official from another euro zone country's national debt office. "But now, they know how to communicate well with investors and manage issues and buybacks so the market is always liquid enough."
Finance Ministry officials in Berlin insist that Bunds are as solid an investment as ever, and that when the EU economy recovers, cutting Germany's budget deficit, the country's debt will regain its top-dog status. But Spain's outperformance of Germany in 10-year bonds -- the most liquid section of the sovereign bond market -- underscores the economic weakness of Europe's largest economy. It may not exactly be a humiliation. But it's the latest sign that, in investors' minds, the divide between the EU's richer and poorer members has all but disappeared. By David Fairlamb in Frankfurt