LESS THAN six months after dumping the downgraded debt of Greece and Ireland, investors are piling back in, sparking the best bond returns in Europe.
Greece’s bonds earned 8.1 per cent this year, the most in the region, making them a “top pick” for Deka Investment GmbH. HSBC Holdings recommends Italy, whose notes gained 4.1 per cent. DWS Investment is buying Irish securities, which jumped 4.7 per cent since March.
German bunds, Europe’s benchmark, fell 0.8 per cent, according to Bloomberg/EFFAS indexes. Bond yields are converging among nations that share the euro for the first time since before Lehman Brothers collapsed in September on signs of a global recovery. That’s a turnaround from March, when credit-rating downgrades drove yields on Greek and Irish 10-year debt to the highest, relative to bunds, since the euro became Europe’s common currency in 1999.
“The fundamental questions whether Ireland will be able to stay in the euro or whether it will default on its debt no longer count,” said Ruediger Kerth, a Frankfurt-based money manager at Union Investment, which has €151 billion under management. “The situation has improved. The bulls are running in the periphery market. People are hunting for high yields.”
Rates on Greek bonds due in 10 years will fall to within 110 basis points, or 1.10 percentage points, of bunds by year-end from 138 basis points on July 24th, according to Andre de Silva, global deputy head of fixed-income strategy at HSBC in London.
The gap reached 300 basis points on March 12th, the widest since January 1999. Spreads on Italian debt will contract to 70 basis points from 90 at the end of last week and 159 on January 27th, Mr de Silva said.
Investors will earn 9.7 per cent from Greek bonds and 7.9 per cent on the Italian securities should HSBC’s forecasts prove correct. Investors in the so-called peripheral nations may also profit because their governments have almost completed raising the money needed this year. Greece met its initial target and Ireland collected 90 per cent. Germany sold 50 per cent of its planned bonds.
“Funding progress has been a key valuation tool for those particular markets,” said Mr de Silva. “Those who have made steady progress have benefited.”
The gap between German yields and those of smaller European economies started to widen in the fourth quarter as credit markets seized up following the bankruptcy of Lehman.
Investors fled to the relative safety of treasuries, bunds and Japanese securities.
Ireland’s spread expanded to 284 basis points on March 19th, the most in 16 years. The rating was lowered by SP in March and then again in June, to AA from AAA, on the cost of propping up the nation’s banks. Irish bonds lost 4.7 per cent in the first quarter.
Yield premiums are narrowing as economic reports stoke optimism that the worst of the global recession may be over. European manufacturing and service industries contracted at the slowest pace in almost a year this month, a survey of purchasing managers by Markit Economics showed on July 24th.
While ratings for some euro members may deteriorate, defaults aren’t likely, SP reiterated this month. “There’s still room for these bonds to outperform,” said Mr Kerth at Union Investment, which is one of the 10 biggest holders of Greek and Irish bonds. “After March, when the situation started to turn, ratings played little role in spreads.”
Betting on peripheral bonds may be too risky with Europe mired in an economic slowdown, said Axel Botte, a fixed-income strategist in Paris at Axa Investment Managers, which has $800 billion in assets.
The International Monetary Fund said in June that the Irish economy will shrink 13.5 per cent in the three years through 2010. Greece’s contracted 1.2 per cent in the first quarter.
Italy cut its growth forecast on July 14th, predicting a 5.2 per cent drop this year, compared with a 4.2 per cent decline forecast in May.
“I would be cautious with the Greek and Italian fundamentals,” said Mr Botte. “We had a narrowing of spreads, so this is not where future performance will be coming from. The narrowing is not due to fundamentals.”
Ireland’s banks may lose as much as €35 billion by 2010, according to the IMF, which said the nation is in an “unprecedented economic correction”.
The loss would amount to almost 20 per cent of the economy, the IMF said.
The amount of government debt to be sold may weigh on prices, said Christoph Kind, who manages $20 billion as head of asset allocation in Frankfurt at Frankfurt-Trust.
Sales may rise to almost €1 trillion in 2010 from a record €870 billion this year should the recession persist, HSBC said earlier this month.
“Supply is a concern for every highly indebted country in this region,” said Mr Kind, who has avoided peripheral-nation bonds in favour of Hungary and Poland.
Gerald Goedel at Deka in Frankfurt, which manages €140 billion, said he was “underweight” peripheral debt until February, meaning he held a smaller percentage of the securities than the benchmark index against which he measures performance.
The turning point came in February, when German Finance Minister Peer Steinbruck said his country would show its “ability to act” should other euro nations get into financial difficulty.
“That’s when I thought things will get better and started buying,” said Mr Goedel. “Even before then, my sense was that the pessimism was overdone, but buying these bonds during that time would be like standing in front of a train.”
European Central Bank council member Athanasios Orphanides said on Friday that signs point to a gradual recovery next year for the euro area.
The euro-region economy will expand 0.6 per cent in 2010 after a 4.3 per cent contraction this year, according to the median forecast of 22 analysts surveyed by Bloomberg. – (Bloomberg)
