Draghi Rally Lets Skeptics Dump Spain for Bunds
Mario Draghi has made it cheaper for investors betting against a resolution of Europe’s debt crisis to switch into top-rated government bonds.
The European Central Bank’s plan to buy the debt of cash- strapped nations boosted Spanish bond values and cheapened German debt. The price of the 1.75 percent bund repayable in July 2022 dropped from 105.92 at the start of June to as low as 100.47 on Sept. 17. The dip in bund prices represents a buying opportunity, according to BlueBay Asset Management Ltd., which oversees $41 billion.
Demand for German debt, perceived to be among the safest securities, is being sustained as Spain weighs a sovereign bailout to supplement a 100-billion euro ($129 billion) bank rescue package and as Europe’s economy slides toward recession. While analysts have raised year-end forecasts for the 10-year bund rate since the ECB outlined its strategy, the median year- end estimate is 1.63 percent, compared with about 1.54 percent currently and almost half the five-year average of 3 percent.
“We like bunds,” said Russel Matthews, a fund manager at BlueBay in London who said he has a “small long position” in German debt. “They are cheap around 1.60 percent. If Spain does request a bailout bund yields won’t get that much higher because of the fundamental backdrop.”
German 10-year yields matched a record 1.127 percent on July 23, three days before Draghi promised to do “whatever it takes” to defend the euro. The Sept. 6 announcement of a plan to buy bonds of countries that request aid helped drive the rate to 1.73 percent on Sept. 17, the most since April 26.
Spanish 10-year yields, which reached a euro-era high of 7.75 percent on July 25, have fallen more than 2 percentage points to 5.69 percent, while Italian 10-year yields have dropped to 5.07 percent from 6.71 percent that day.
The selloff in bunds may prove temporary, according to strategists at Royal Bank of Scotland Group Plc, who forecast the rate will end the year at 1.50 percent. Money managers at Frankfurt Trust Investment GmbH and Glendevon King Asset Management said they may buy should yields reach 2 percent.
“By the end of the year things will have got a bit worse,” said Nicola Marinelli, who oversees $160 million at Glendevon King in London. “There will be another wave of flight to bunds and the rates may come back down to around 1.4 percent.”
Even as policy makers strive to end the three-year debt crisis, the region’s economic outlook is weakening. Euro-area surveys on Sept. 20 showed services and manufacturing output fell to a 39-month low in September adding to evidence the economy is heading for a recession. Figures yesterday showed German business confidence unexpectedly fell to the lowest in more than two and a half years in September.
“We are in a period where the ECB has laid down its framework to save the euro but the fundamentals will ultimately creep back in and you will see new problems flare,” said Harvinder Sian, a fixed income strategist at RBS in London. “Bunds will remain supported. I think 1.55 percent to 1.70 percent is a good entry location.”
Spain is in its second recession in three years, endangering plans to trim its budget deficit and avoid a bailout. The euro-region economy will probably shrink 0.4 percent this year, the ECB said this month.
The euro also rallied following Draghi’s comments, climbing 5.2 percent against the dollar since July 26, and strengthening by 4.5 percent against the yen.
“This is an opportunity to protect yourself,” said Bob Noyen, chief investment officer at Record Plc (REC), a London-based currency manager that oversees about $31.5 billion. “Europe’s big structural problems haven’t been resolved. There is a significant amount of systemic risk in the system. We think hedges will be potentially valuable.”
Record set up a fund in June 2011 designed to profit when stress in Europe’s debt crisis intensifies. Noyen is using forwards and options contracts to bet on further euro weakness, he said.
Investors betting that Draghi’s strategy to tame borrowing costs for Italy and Spain will succeed say increased appetite for higher-yielding assets will damp demand for bunds.
“We think the bund yield will continue to rise gradually,” said Nick Eisinger, a sovereign analyst with Fidelity Investments in London, which oversees $1.6 trillion. “Things appear to have stabilized in the euro-region, so support for bunds has dissipated a little bit.”
Greater fiscal integration between the euro’s 17 nations, which would see Germany deploying its balance sheet to help weaker countries, may also undermine bunds, Eisinger said, decreasing the nation’s appeal as a haven.
The German 10-year yield remains historically low even as central bank in the U.S. and Japan have pumped money into their economies this month to boost growth. The Federal Reserve said on Sept. 13 it would buy mortgage securities, while the Bank of Japan (8301) unexpectedly added 10 trillion yen ($129 billion) to its stimulus program on Sept. 19.
German bonds returned 2.6 percent this year through yesterday, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Spanish securities added 2 percent and Italy’s earned 15 percent.
“As the bund yield rises you will see buyers coming in,” said Werner Fey, a fund manager at Frankfurt Trust Investment GmbH, which oversees 6.5 billion euros of fixed-income assets. “All the liquidity provided from the central banks will also help support core bond markets.”
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