Sovereign Debt Losses Extend to Highest-Rated European Bonds: Euro Credit
Bailouts for Ireland and Greece and speculation that Portugal and Spain may need aid are prompting investors to shun some of Europe’s highest-rated bonds.
The cost of insuring German debt against default rose yesterday to the highest since May. The yield on 10-year French securities climbed to as much as 3.247 percent, the most in more than in six months, and the extra yield, or spread, investors demand to hold 10-year Belgian bonds instead of similar-maturity German bunds climbed to the most since at least 1993.
“More rescuing means a bigger bill for everyone and this partly explains the pressure on yields in some countries, including Germany,” said Elwin de Groot, a senior market economist at Rabobank Groep in Utrecht, Netherlands. “Now we have the deal with Ireland, there’s speculation about whether we should rescue Portugal or even Spain after that. That’s creating an environment in which there’s going to be risk transfers.”
Ireland’s decision on Nov. 28 to accept an 85 billion-euro bailout ($111 billion) failed to end the spread of the European debt crisis, fueling investor concern about the willingness and ability of Europe’s stronger nations to foot the price of future rescues. The cost of insuring Portuguese, Spanish and Italian bonds climbed to records, as investors bet the EU’s 750 billion- euro financial lifeline may not be enough to ward off defaults, undermining confidence in euro-denominated debt.
Standard & Poor’s said it may cut Portugal’s credit ratings on concern that the government has made little progress on boosting economic growth to offset the effect of budget cuts.
The country sold 500 million euros of 12-month bills today, issuing them at an average yield of 5.281 percent, up from 4.813 percent at the previous auction on Nov. 17, data from the country’s debt agency showed. The auction attracted bids for 2.5 times the amount offered, compared with a bid-to-cover ratio of 1.8 in November.
French and German bonds declined relative to U.S. and U.K. counterparts this week. The debt underperformed even after the Irish rescue and German Chancellor Angela Merkel and French President Nicolas Sarkozy toned down calls for bondholders to take losses in future restructurings. Some investors shifted from euro-region debt to seek refuge in gilts on the prospect that further bailouts may cause a splintering of the euro area.
The extra yield investors demand to hold 10-year French bonds instead of U.S. Treasuries surged 11 basis points since the end of last week to 39 basis points on Nov. 29, the most since July 2009, based on closing prices. The spread between yields on U.K. 10-year bonds and bunds, Europe’s benchmark government securities, has narrowed by almost half since May and was at 56 basis points as of 11:23 a.m. in London.
Fewer Euro Members
“There’s a perceived risk that there could be a credit redistribution from weaker credits to the stronger ones,” said David Schnautz, a fixed-income strategist at Commerzbank AG in London. “This risk hasn’t been priced in to a large extent.”
Spain and Portugal will likely follow Ireland in tapping the EU’s fund and the region’s inability to fund future bailouts will probably force some of the 16 euro nations to abandon the currency within five years, Mohamed El-Erian, the chief executive officer at Pacific Investment Management Co., said in an interview on CNBC yesterday.
Concern that countries such as Germany may balk at funding future aid packages intensified on Nov. 16 after Austrian Finance Minister Josef Proell said he may withhold the country’s share of the bailout for Greece if the government didn’t comply with financial targets.
Top Credit Ratings
Austrian, Belgian, Dutch and French bonds fell on Nov. 25 after European Central Bank council member Axel Weber said a day earlier that if necessary, governments can increase the size of the euro area’s bailout fund that Ireland is the first nation to tap. Klaus Regling, who runs the largest part of the fund, told Bild-Zeitung in an interview published that day the package was big enough for all member states.
“That was the first time that the euro-debt crisis turned into a negative for the core European bond markets,” said Marius Daheim, a senior fixed-income strategist at Bayerische Landesbank in Munich. “Smaller core countries such as the Netherlands and Austria in particular might be vulnerable because of that.”
Austria, France and the Netherlands have the top Aaa rating from Moody’s Investors Service, while Belgium is ranked one step lower at Aa1, the same as Spain. Ireland’s grade is one level below that at Aa2, down from Aaa as recently as July 2009.
S&P said yesterday it placed Portugal’s A-long-term and A-2 short-term foreign and local currency sovereign credit ratings on “CreditWatch” with “negative implications.”
“Policies the government has pursued have done little to boost labor flexibility and productivity,” S&P’s report said. “We project that the economy will contract by at least 2 percent in 2011 in real terms.”
The EU-International Monetary Fund backstop announced in May won’t be enough should Spain need help and policy makers are too divided to agree quickly on ways to shore up the financial program, according to Robin Marshall, a director of fixed income at Smith & Williamson Investment Management.
“There was a feeling the fund was large enough to cope with likely smaller countries, and then you come to this issue of a large one like Spain where the banking system exposure and the whole size of the economy makes it look inadequate,” said Marshall, who helps manage about $20 billion in London. “The size of the fund wouldn’t matter so much if there was a clear willingness or agreement among policy makers that if necessary they could expand it.”
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