A logo of the euro stands in front of the headquarters of the European Central Bank in Frankfurt. Investors’ interest with eurozone bonds is starting to wane, as political risks dent faith that the ECB alone will be able to ensure the bloc’s recovery.
Investors’ love affair with low-rated but high-yielding eurozone bonds is starting to wane, as political risks dent faith that the European Central Bank alone will be able to ensure the bloc’s recovery.
Greek bond prices fell to their lowest since May yesterday, on track to record their first quarter of losses since early last year, while momentous gains in Spanish and Italian debt seen over the last year are also dwindling.
The prospect of Greece escaping the strict conditions of its bailout programme, a bid for independence by one of Spain’s richest regions and rumours of moves to topple the Italian prime minister are all troubling investors.
Nerves have not been soothed by management changes last week at the world’s biggest bond fund, Pimco, which created uncertainty about what it may do with its holdings of so-called peripheral eurozone debt.
“There is this weird feeling that everybody is spooked... everybody is really worried about the flows,” said Hans Humes, chief investment officer at Greylock Capital in New York.
Ten-year Greek bond yields, which rise as prices fall, rose 28 bps yesterday to hit 6.81%, levels not seen in more than four months.
The gap between yields on Greek bonds – the lowest-rated sovereign debt in the single currency bloc – and on benchmark German Bunds stood at its widest since March.
The rise in yields comes as investors worry that the Greek government could torpedo its chances of further debt relief as it tries to appease an electorate by curtailing a deeply unpopular bailout programme.
Across the Adriatic, another government crisis is stirring.
Italian Prime Minister Matteo Renzi overcame fierce opposition to win backing in his party for labour reforms on Monday, but rumours of a leadership challenge persist. Renzi, 39, who came to power in February, has struggled to live up to promises to get the eurozone’s third largest economy back on track, with the government revising upwards debt and deficit forecasts this week.
In Spain, a burgeoning separatist movement in well-off Catalonia shows many of the hallmarks of the Scottish referendum that rattled UK markets earlier this month.
Spain’s constitutional court on Monday suspended a vote scheduled for November 9, but with a large majority of Catalans set on holding a referendum, investors are worried that a region accounting for a fifth of the country’s output could secede.
The court’s move to block the referendum came as a relief to markets yesterday, with yields in both Spain and Italy edging down around 3 bps. But strategists point out that recent gains have been more restrained. Fervent investor demand for the relatively high return on offer in Europe’s periphery has sent government borrowing costs to record lows.
Now, strategists say, investors have become more cautious, trading more regularly on negative headlines rather than just holding the bonds in the belief that ultra-easy monetary policy will continue to ensure their performance.
“We are in a period of quite high volatility in peripheral countries,” said Alessandro Giansanti, senior strategist at ING. “Every time we see some weakness in equity markets due to some geopolitical event or other, it is a warning signal for widening in peripheral spreads.”
Italian 10-year yields have fallen around 30 bps this quarter, around half the decline seen in the last two quarters. Spanish equivalents - having suffered their worst week since June 2013 earlier this month - have fallen some 45 bps this quarter, which compares with 56 bps in Q2 and 92 bps in Q1.
“You don’t need to be a genius to see that clearly you’ve travelled a lot of the way that you are going to travel,” said Mark Dowding, co-head of investment grade at Bluebay.
The consensus among strategists is that this slight pull back from the periphery should be just a blip as long as investors believe the ECB will eventually embark on a full-scale sovereign bond-buying scheme, known as quantitative easing.
Data showed eurozone inflation rooted at 0.3% in September, well below target and supporting the argument that the ECB’s policy efforts are falling short.
Banks including RBS are calling for QE as early as November, while others see it as unlikely before March.
But some ECB policymakers have been eager to play down the prospect of QE, which they say may not work as effectively in the eurozone as it did in the US and Britain and could violate a ban on the ECB funding governments.
A Reuters poll published last week showed economists still see only a 40% probability of the ECB purchasing sovereign bonds.
“Were (central bank chief Mario) Draghi to come out and categorically rule out forever QE as a possibility, (peripheral) spreads would go higher,” said Bluebay’s Dowding, adding that, conversely, QE would narrow the gap between Spanish and German 10-year bonds by around 50 bps.
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