Spain Trails Italy as Growth Concern Halts Rally: Euro Credit
Spanish bonds are underperforming those of Italy as concern the Iberian nation’s economy will struggle to grow has left it trailing in a rally sparked by two rounds of extraordinary European Central Bank lending.
Spain’s benchmark borrowing costs rose above Italy’s for the first time in almost eight months last week after Prime Minister Mariano Rajoy said his nation’s 2012 deficit would be higher than agreed at budget talks with the European Union. Italy’s 2011 deficit narrowed more than economists forecast even as the economy slipped into recession.
“The spotlight is back on Spain’s fiscal performance,” said Peter Chatwell, a fixed-income strategist at Credit Agricole Corporate & Investment Bank in London. “Italy appears to still be meeting targets. On that basis alone we could continue to see Italian bonds outperforming Spanish bonds.”
Spain’s 10-year bond yields closed higher than similar- maturity Italian securities on March 5 for the first time since Aug. 19. Last month Italian two-year rates became cheaper than Spain’s for the first time since Sept. 2.
The extra yield, or spread, investors demand to hold Spanish 10-year debt rather than similar-maturity Italian securities was 14 basis points at 11:50 a.m. London time. Italian debt yielded 80 basis points more than Spanish bonds on Dec. 8. The two-year spread was 51 basis points.
The ECB awarded 529.5 billion euros ($695 billion) in three-year loans to 800 European banks on Feb. 29, after supplying 489 billion euros to 523 financial institutions on Dec. 21. Under the so-called longer-term refinancing operation, banks can borrow at the average of the central bank’s key interest rate, currently at a record-low 1 percent, and use the funds to purchase higher-yielding assets such as Italian and Spanish debt.
Spanish bonds have handed investors a 7.7 percent return since the ECB announced its lending program on Dec. 8, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Italian securities have advanced 14 percent in the period.
The yield on Italy’s 10-year note was 4.97 percent, while the nation’s two-year was at 1.83 percent. Spanish 10-year yields were 5.10, while two-year rates were 2.35 percent.
“All the LTRO has done is concentrate Spanish government bonds within Spanish banks,” said Peter Allwright, who helps oversee around $4 billion as head of absolute rates and currency at RWC Partners, a London-based asset-management company. “We are so negative on Spain. The main issue for us is that the debt dynamics have deteriorated so quickly.”
Prime Minister Rajoy said March 2 that his nation’s 2012 deficit would be 5.8 percent of gross domestic product compared with the previously agreed 4.4 percent. EU leaders signaled he must stick to the target even though Spain overshot last year’s goal and is facing recession.
Rajoy has already adopted a 15-billion euro package of savings and would need to find another 25 billion euros to meet this year’s target, according to an estimate from Moody’s Investors Service.
The announcement added to evidence suggesting Spain’s economy is struggling. A services index fell to the lowest since November last month and a manufacturing measure dropped in February. The Spanish jobless rate is 23 percent. The government is also grappling with a banking crisis, offering help to lenders saddled with 175 billion euros of troubled assets linked to real-estate.
While the services gauge for Italy also fell last month, the manufacturing measure grew and the nation’s jobless rate is at 8.1 percent.
Credit-default swaps on Italian debt have narrowed more than 100 basis points since the start of the year, according to data compiled by Bloomberg, while contracts on Spain’s debt are little changed.
“It is clear that the market is more worried that the Spanish authorities won’t be able to reach the budget goals,” said Elwin de Groot, a market economist at Rabobank Nederland in Utrecht. “In the near term, there is a bigger risk that further austerity measures in Spain will undermine its budgetary strategy.”
Italy’s performance may be tested later in the year as its borrowing needs are greater than its neighbor’s.
“Spain is well ahead of the curve with regards to supply,” said Michael Leister, a fixed-income strategist at DZ Bank AG in Frankfurt. “Italy has been much slower and also much more active at the short-end, so supply pressure will intensify going forward.”
‘Bad for Growth’
Italy has issued more than 65 billion euros of debt and still requires another 271.4 billion euros to pay back investors, according to data compiled by Bloomberg. Spain has sold about 45 billion euros of securities and plans to issue 128 billion euros more.
Spain’s economy contracted 0.3 percent in the fourth quarter of last year, while Italy’s shrank 0.7 percent, the European Union said yesterday.
The Spanish government’s double headache of tackling fiscal and banking crises will be “bad for growth,” said Jacob Kirkegaard, research fellow at the Peterson Institute for International Economics in Washington.
“Increasingly Italy will look the stronger of the two,” Kirkegaard said.
-- With assistance from Simon Kennedy in London. Editor: Mark McCord, Nicholas Reynolds
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