Low costs, yield hunt to propel long-term euro zone bond sales in 2015

Euro zone governments are preparing to sell a record amount of bonds next year, tilting towards more long-term debt as they try to lock in historically low borrowing costs.

Analysts estimate the bloc’s biggest sovereign borrowers will sell a third more debt than in 2014, with Germany the notable exception as it aims to eliminate its budget deficit.

Investors, on the other hand, will seek higher yields from lower-rated issuers such as Italy, Spain and Portugal, reassured by expectations that the European Central Bank will become a buyer in 2015.

The prospect of the ECB expanding its asset purchases to include sovereign bonds early next year has given fresh impetus to a 2-1/2-year rally in euro zone debt that has driven borrowing costs to all-time lows.

“The treasuries are very keen to lock in these ultra-low yield levels and extend duration,» said Michael Leister, a strategist at Commerzbank. «Demand is still there even at these yield levels, especially with the ECB most likely coming in as a structural buyer.”

The governments with lower credit ratings are anxious to exploit the benign market conditions to increase the average life of their debt stock. That means re-funding will be required less often, an advantage as at some point the era of ultra-low ECB interest rates, originally imposed to tackle the financial crisis, must come to an end.

Ten-year Spanish and Italian 10-year yields are less than 2 percent ES10YT=TWEB IT10YT=TWEB, below those of U.S. Treasuries, as the threat of deflation in the euro zone exacerbated by sliding oil prices pressures the ECB to begin a program of quantitative easing (QE).

At the height of the euro zone crisis, investors were reluctant to buy anything longer than five-year bonds from troubled governments. However, those worries have dwindled since ECB President Mario Draghi promised first to save the euro and then, last month, to tackle excessively low inflation by whatever means necessary.

In a recent Reuters poll, 25 out of 27 economists expected the ECB to start buying sovereign debt under a QE program, probably early next year.

Analysts say Spanish and Italian bonds still look relatively attractive against German benchmarks, on which yields have dropped to all-time lows below 0.60 percent and could fall to 0.50 percent in the next few weeks.

The euro zone’s 11 biggest government borrowers are forecast to issue bonds worth 927 billion euros ($1.1 trillion) in 2015, up about 34 percent from this year’s projected total, according to an average estimate of six analysts.

Germany, the region’s biggest economy, is alone in bucking the trend. It plans to cut issuance to its lowest since 2002 next year as it seeks to present its first balanced federal budget in almost half a century.

Although countries such as Spain have made progress in cutting their budget deficits, they still plan to increase issuance to cover maturing debt estimated by analysts at 86 billion euros, up from 62 billion this year.

Spain was even more aggressive than neighboring Italy in issuing short-term debt in 2011 and 2012 to tap into demand created by the ECB making crisis loans to commercial banks. Madrid faces a similar refinancing hump in 2016, making it vital for it to lengthen the average maturity of its debt.

The Tesoro, Spain’s debt management office, is scheduled to announce its 2015 funding needs in the first week of January but gross issuance is forecast at 144 billion euros on average, up from 133 billion this year.

“We expect the Tesoro to continue increasing its average debt maturity which is planned to climb to up to 6.4 years in 2015 from 6.28 years currently,» Nomura analysts said in a note.

Exceptional conditions

Belgium’s equivalent agency also plans to issue more long-term debt in 2015 as it needs to refinance more maturing bonds next year.

Last week, the head of France’s AFT debt agency said he expected growing demand for longer maturities to continue next year, adding it was looking into adding a new 15 or 20-year benchmark. «Financing conditions today are exceptional,» AFT chief Ambroise Fayolle said.

France is expected to keep borrowing at low interest rates despite possible downgrades to its AA rating from Moody’s and Standard & Poor’s next year. The deep liquidity of its markets and expectations that it will keep a relatively high rating make it an attractive alternative to Germany, analysts said.