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BlueBay, BlackRock see euro area bond rally fading out

By Lucy Meakin and Neal Armstrong

The advance in euro-area government bonds that pushed the 10-year yields of Ireland, Italy and Spain to record lows today is about to end, according to investors from BlueBay Asset Management LLP to BlackRock Inc.

Italian 30-year yields fell below 4 percent for the first time since 2006 as banks from Goldman Sachs Group Inc. to UBS AG predict policy makers will cut borrowing costs next month. European Central Bank President Mario Draghi said yesterday officials are “comfortable” about taking further action if needed. Portugal’s yield spread over German bunds shrank to the narrowest in four years after Standard & Poor’s raised the nation’s credit-rating outlook to stable from negative.

“Markets have clearly moved to expect a rate cut as a minimum at the June meeting,” said Mark Dowding, a money manager in London at BlueBay, which oversees $57.8 billion. “The burden of proof is in the data and Draghi may find it difficult to deliver in June. The market is getting ahead of itself. The sense in the periphery is that we’ve now seen the vast majority of the spread tightening that we’re looking for.”

Spain’s 10-year yield climbed three basis points, or 0.03 percentage point, to 2.92 percent at 4:51 p.m. London time after sliding to 2.85 percent, the lowest since Bloomberg began compiling the data in 1993. The 3.8 percent bond due in April 2024 fell 0.29, or 2.90 euros per 1,000-euro ($1,377) face amount, to 107.545.

Italy’s 10-year yield increased four basis points to 2.95 percent after declining to 2.89 percent. The rate on the nation’s 30-year bonds dropped to 3.985 percent, the least since January 2006.

Staff Projections

“The Governing Council is comfortable with acting next time, but before we want to see the staff projections that will come out in the early June,” Draghi said yesterday in Brussels after the ECB kept its benchmark rate at a record-low 0.25 percent. “There wasn’t a decision today. It’s a preview of the discussion we will have next month.”

Goldman Sachs and UBS predict the ECB will cut its refinancing rate to 0.1 percent and its deposit rate to minus 0.15 percent at its June 5 meeting. JPMorgan Chase & Co., Nordea Bank AB, Danske Bank A/S, and UniCredit SpA also revised their forecasts following yesterday’s press conference, and now expect interest-rate cuts next month.

Governing Council member Erkki Liikanen told Bloomberg in Helsinki today that Draghi’s signals yesterday reflected the central bank’s “common view.”

Speculation of further easing by the central bank has pushed down the yields of peripheral nations. The average yield to maturity on bonds from Greece, Ireland, Italy, Portugal and Spain fell to 2.13 percent yesterday, the least in the euro era, according to Bank of America Merrill Lynch indexes.

‘QE Carrot’

“As long as Draghi continues to say the ECB will try to be as accommodative as possible, and dangle the QE carrot, people will buy these bonds on expectation peripheral yields will converge with Germany’s,” Grant Peterkin, Geneva-based senior portfolio manager in fixed income at Lombard Odier Investment Managers, which oversees $48 billion, said yesterday.

“Because everyone is long peripheral bonds and credit, it could be tricky when people realize what they are holding and want to get out of these positions,” he said, referring to a bet an asset will rise.

Draghi’s comments indicate the ECB is unlikely to extend its stimulus measures to asset purchases, according to Scott Thiel, head of European and global bonds in London at BlackRock, the world’s largest fund manager.

Portugal, Slovenia

“In the European periphery we remain invested in Portuguese and Slovenian government bonds,” Thiel wrote yesterday in an e-mailed report. “However, given their significant spread compression to German bund yields in recent weeks and in light of excessive market expectations for imminent quantitative easing in the euro zone, we have reduced these positions.”

Portugal’s bond yields have fallen by more than half since September amid easing concern the country will need more aid. The nation’s 10-year yield rose eight basis points to 3.54 percent today, down from 7.45 percent on Sept. 16. The rate on Slovenia’s 10-year bond was little changed at 3.40 percent.

German 10-year bund yields were little changed at 1.45 percent. The extra yield investors demand to hold similar-maturity Portuguese securities over bunds narrowed to as little as 199 basis points today, the least since May 2010.

Volatility on Austrian bonds was the highest in euro-area markets today, followed by those of the Netherlands and Germany, according to measures of 10-year debt, the yield spread between two- and 10-year securities and credit-default swaps.

Irish 10-year yields fell as low as 2.643 percent, sliding beneath the rate on similar-maturity U.K. bonds for the first time since 2008. The U.K. 10-year gilt yield increased four basis points to 2.68 percent.

Spain’s government securities returned 8.1 percent this year through yesterday, according to Bloomberg World Bond Indexes. Portugal’s gained 16 percent, Italy’s 7.7 percent and Germany’s earned 3.3 percent.

[Bloomberg]

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