How can you tell whether a market price is right or wrong? One indication is extremely high volatility. Strong fluctuations can shake confidence so badly that nobody dares to lend out money any more. Interbank lending then becomes virtually impossible and the banks can no longer issue any bonds either, even when these – like covered bonds – are well secured.
1 Considering the post-1999 era in retrospect, the euro area spreads have indeed declined significantly since the introduction of the euro (see slide 3). In fact, euro area spreads are small today and actually lower than the ones observed between Canadian provinces.