ECB trumps political risks for shorter-dated bonds

If you’re looking for evidence that investors are starting to fret about political risks in Europe, you’ll find it only in longer-maturity bonds.

Spanish two-year notes rose the day after Catalans voted for independence in an unofficial referendum on Nov. 9. In Italy, growth in support for a political movement wanting to exit the euro hasn’t stopped two- and five-year yields falling to records. Yet longer term, the faith of investors is being tested. The nations’ 30-year bonds yield the most relative to their 10-year counterparts since before the euro’s inception.

“You can live with the volatility in the short end because if you know you are going to hold it to maturity it’s not going to hurt you,” said Allan von Mehren, chief analyst at Danske Bank A/S in Copenhagen. “In the long end, it’s getting more tricky. If yields should really start to go up, you’ll be hit more in the longer maturities.”

The prospect of political agitation in some countries is being mitigated by the European Central Bank as it considers ways of funneling money into the region’s stagnating economy.

Appetite for securities with shorter maturities is being sustained as ECB officials keep open the possibility of large- scale bond purchases, or quantitative easing. Bonds with longer maturities are underperforming the rest of the market even as investors expect inflation over the next three decades to be less than the ECB’s 2 percent target.

Relative Value

Spanish and Italian bonds are attractive relative to the lower yields on offer in Germany and the risk for investors is minimized “if you buy into the view that there will be the ECB buying,” their bonds, said Craig Veysey, London-based head of fixed income at Sanlam Private Investments Ltd.

“Even though there is a possibility that they might happen in the longer end, I’d imagine most of them would be concentrated in short-dated investments,” he said on Nov. 10.

While the whole market was supported by ECB President Mario Draghi’s pledge in July 2012 to safeguard the euro’s future, policy makers have made little headway in tackling stagnant growth and joblessness that reached a record last year.

Euro area inflation, at 0.4 percent last month, is less than half the ECB’s target, while unemployment stands at 11.5 percent on average, rising to 26 percent in Greece and 24 percent in Spain. Disinflation or deflation is a greater threat to the region than inflation over the next year, according to 89 percent of respondents in a Bloomberg Global Poll of international investors last week.

Anti Austerity

Parties opposed to austerity measures have been in the ascendancy in southern Europe particularly.

Alexis Tsipras’s Syriza party is leading opinion polls in Greece, while Podemos, led by Pablo Iglesias, has overtaken the two largest parties in in Spain, a poll for El Pais newspaper showed this month. In Italy, the main opposition Five Star movement will seek a referendum on Italy’s euro membership, founder Beppe Grillo said in a post on his blog last month.

Still, little of that is reflected in the short end of the bond market, with Italian two-year note yields dropping to as little as 0.21 percent in September.

Yield Spreads

At 0.62 percent at the end of last week, the Italian two- year rate compares with an average 3 percent since 1999. Spain’s two-year yield was at 0.45 percent, down from 7.15 percent at the height of the sovereign debt crisis in July 2012.

The extra yield investors get for holding Italian 30-year bonds instead of those maturing in a decade was 137 basis points on Nov. 14, having risen to 141 basis points on Nov. 7, the most since Bloomberg started collecting the data in 1994.

In Spain, the spread was at 139 basis points, after widening to 142 basis points in September, the most since at least 1998. While Spain’s 10-year bonds yield 23 basis points less than similar Treasuries, over 30 years the yield is 44 basis points more than the country’s U.S. peers.

“There are political risks, not only in Spain but in general, and that’s why I prefer the short end,” said Peter Schaffrik, London-based head of European rates strategy at Royal Bank of Canada. “The curve will remain relatively steep.”


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