Euro area sovereign bond market’s reactions to COVID-19 and responses

This paper examines sovereign bond yields’ reactions to the COVID-19 pandemic and to key responses in the euro area using the short-term event study methodology. The focus of this study is the behavior of safe assets, and the purpose is to expand the literature on financial markets amid COVID-19 and the flight-to-liquidity effect in the euro area. The empirical event study of this paper shows that yields of the safe and liquid sovereign bonds decreased as a result of significant bad news regarding the pandemic in the euro area. Furthermore, the results imply that investors in the euro area adjusted to the severeness of the pandemic in Europe on March 9, 2020. Conversely, as a consequence of significant good news, the prices of the euro area safe sovereign bonds fell making their yields increase. These results demonstrate the changing price premium for liquidity when uncertainty shifts. Quantitative Easing resulted in significant reactions, increase in yields, only for the first announcement of the massive Pandemic Emergency Purchase Programme by the European Central Bank. Reactions to major fiscal responses in Europe were significant only for short-term fiscal measures and resulted in increase in yields as well. These findings suggest that the responses were seen as calming forces decreasing uncertainty in the markets. The results of this study imply evidence of the flight-to-liquidity effect in highly liquid government bonds of the highest credit rating in the euro area. Based on the results, investors value liquidity in times of increased uncertainty in the markets and tend to reallocate their funds towards safer and more liquid assets as a reaction to negative economic outlooks. Conversely, positive news and announcements of monetary and fiscal responses were shown to result in decreased demand for the safe and liquid sovereign bonds. These results are consistent with earlier literature on the flight-to- liquidity and expand the literature of the price premium in safe and liquid assets in the euro area