How Do Macroeconomic Fundamentals Affect Sovereign Bond Yields? New Evidence from European Forecasts

Abstract

Macroeconomic fundamentals impact the long-term insolvency problem of a country. This article empirically assesses the role played by both macroeconomic and fiscal fundamentals, proxied by a set of European Commission’s forecasts, in affecting sovereign bond yields. We look at a large panel of 25 European countries between 1992 and 2015. By means panel and time-series approaches, we find that lower short-term interest rates and better fiscal institutions tend to lower bond yields. The better the economic and fiscal outlooks going forward, the lower the yields demanded in international markets. Timing also matters: investors seem to pay more attention to forecasts the shorter the forecast horizon, and they started carrying more weight since the Global Financial Crisis. Finally, the impact of yields’ determinants is different across countries, being more prominent in those characterized by economic hardship conditions (Greece, Ireland, Spain, and Portugal). (JEL codes: C23, E44, H68)