Sovereign risk in the Eurozone has dominated both the headlines and thoughts of bond investors in 2010. Despite the bailouts of Greece and Ireland, and other initiatives such as the European Financial Stability Facility to underpin sovereign debt in the region, investors remain fearful over the contagion spreading to Portugal and Spain.
Luke Spajic, European head of credit portfolio management at Pimco, says 2010 was characterised by some "extraordinary moves in spreads", with "markets re-pricing sovereign debt from interest rate risk to credit risk".
He believes the potential spill over effects from the Eurozone crisis could include the contamination of local banking systems and corporates struggling to access funding.
"The market has gone from Greece to Ireland, and is now waiting on Portugal. The whole structure of the European Union, given that is does not have a common fiscal backdrop, is what policymakers are likely to test," says Spajic.
As to what policymakers need to do to restore confidence, Spajic says that, at the national level, governments must ensure the austerity plans they have set out are met. More broadly, he says "there needs to be a greater effort to coordinate policy [across the Eurozone), especially on the fiscal side".