How Do Experts Forecast Sovereign Spreads?

Abstract

This paper assesses how forecasting experts form their expectations about futuregovernment bond spreads. Using monthly survey forecasts for France, Italy and theUnited Kingdom between January 1993 and October 2014, we test whether respondentsconsider the expected evolution of the fiscal balance-and other economicfundamentals-to be significant drivers of the expected bond yield differential over abenchmark German 10-year bond. Our main result is that a projected improvement of thefiscal outlook significantly reduces expected sovereign spreads. This suggests thatcredible fiscal plans affect market experts' expectations and reduce the pressure onsovereign bond markets. In addition, we show that expected fundamentals generally play amore important role in explaining forecasted spreads compared to realized spreads.

Keywords: Bond markets, France, Italy, United Kingdom, Germany, Bonds, Bond yields, Cross country analysis, Econometric models, Regression analysis, Forecasting models, Time series, market expectations, sovereign bond spreads, survey data, Consensus Economics.

JEL Classification: E62, G10, H30