Monetary policy expectations and sovereign risk dynamics in the Eurozone

We empirically assess the dynamic linkages among sovereign bond yield spreads (both short- and long-term) and monetary policy rates/spreads during the Eurozone's sovereign and banking crises in the post-2008 period when unconventional monetary policy replaced conventional policy. Our focus is on two subperiods, the crisis period (30 November 2009 to 25 July 2012) and the tranquil period (26 July 2012 to 30 April 2014). For the first subperiod, we noted significant spillovers from the overnight interest spreads spread to almost all sovereign bond yield spreads, at both the mean and volatility levels. Thus, during that period expectations on monetary surprises led bond spreads and their corresponding volatilities compared to the tranquil period, regardless of the bond yields maturities. Overall, we infer that monetary policy and sovereign risk were highly linked during the crisis period and thus, the interest-rate monetary policy transmission mechanism was effective in reducing these yield spreads.