Are euro-zone government bonds favourably valued?

Government bond yields have continued to fall in much of the euro-zone in response to improving economic conditions. Spreads over German Bunds have fallen to multi-year lows in many nations. But investors’ optimism may have swung too far given that the cost of insuring against sovereign default in Ireland, Spain and Italy appears to be lower than might be expected given their current credit ratings. Moreover, we do not expect growth in these countries to be strong enough to ease debt burdens to more sustainable levels any time soon.