Fixed Income  

News Analysis: Getting Europe back on track

Global investors are racing to snap up Spanish government debt, pushing foreign ownership to near peak levels reached three years ago.

Foreign holdings of Spanish government bonds have soared since early 2012 by more than €70bn (£57.6bn) to €182bn, close to its €188bn peak reached in April 2011, according to Barclays.

Meanwhile, interest in other peripheral eurozone government debt has also surged in the past two years.

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Bond yields for Portugal, Ireland, Italy, Greece and Spain, have all fallen recently, with 10-year Spanish bonds dropping below 3.1 per cent last month, while five-year bond yields sunk below those on US Treasuries of the same maturity.

While politicians and central bankers of the peripheral countries have welcomed this as a sign of increasing confidence, not everyone greets it as good news.

Stewart Cowley, Old Mutual investment director, fixed income and macro, says: “Spanish and Italian debt is now caught in an unholy feedback loop; it is not being bought because things are good, it’s being bought because things are so bad.

“The self-inflicted wound of increasing the need for banks to hold government bonds, combined with the need from retail investors for income in an income-less world is pushing investors into peripheral European bonds. Opportunist trend followers are exaggerating the effect. This isn’t so much a race to the bottom, as a race to the positively subterranean.”

Mr Cowley says that while the European Central Bank (ECB) stares deflation in the face, with an ever-shrinking quantity of money in Europe behind it, the markets are doing its work by driving yields and market rates down, while it “sits helplessly on the sidelines.”

Bryn Jones, Rathbones Unit Trust Management’s fixed income specialist also voices concern. “Five-year Spanish government bonds are on a lower yield than UK gilts of the same maturity, even though the UK government is AA rated, while Spanish debt is BBB,” he explains.

“So you can invest in a government bond which has a lower credit quality, but gives you a lower return. That tells me that things are relatively expensive, so we haven’t been buying Spanish government debt recently.”

Rathbones invested in Portuguese and Irish debt in 2011 and recently took profits of 10 per cent and 6 per cent respectively. “Most of the juice has been squeezed out of the Mediterranean fruits,” he claimed.

“All the easy stuff has gone.”

But could the large amount of peripheral debt in foreign ownership be of concern, in the event of another eurozone crisis?

Mr Jones believes it would be more destabilising if the Spanish banks had to buy their own debt and welcomes foreign ownership as a sign of foreign direct investment in the country. Jack Kelly, Standard Life Investments’ investment director for government bonds, bought European peripheral debt roughly nine months ago and has added incrementally since then.

“Foreign ownership is a double-edged sword, in the sense that on paper, potentially, you are more likely to exit if you see more uncertainty in a debt market,” he says.