Italian and Portuguese bonds rallied in 2012 as euro-area government securities had their best year on record after policy makers stepped up efforts to contain market turmoil that threatened to destroy the currency bloc.
A pledge in July from European Central Bank President Mario Draghi to do “whatever it takes” to safeguard the monetary union pulled down Spain’s borrowing costs from a euro-era record. Irish securities delivered the best returns since 1993 as the ECB outlined a bond-buying plan that eased tension in Europe’s three-year-old debt crisis. German bunds underperformed French and Austrian peers as record-low yields dented demand for the region’s top-rated fixed-income assets.
“We have seen a significant change in sentiment,” said Mohit Kumar, head of European fixed-income strategy at Deutsche Bank AG in London. “Portugal, Ireland, Italy, they’ve all done really well. The primary support for the market came from the ECB, which removed the risk of an aggressive selloff in any of the markets and of a breakup of the euro region.”
Portuguese bonds handed investors a 57 percent return through Dec. 28, the largest since at least 1994, according to indexes compiled by Bloomberg and European Federation of Financial Analysts Societies. Italian debt rose 21 percent, the first annual gain since 2009, while Irish sovereign securities returned 29 percent.
The gains in Italian and Portuguese securities followed their worst year on record in 2011, when investors’ faith in lawmakers’ ability to manage debt burdens across the region faded. As market turmoil deepened, European leaders outlined plans for tighter bank supervision, budget coordination and a so-called political union, while the ECB said it would backstop the government-bond market by buying securities of distressed countries that request aid from the region’s rescue fund.
The action prompted money managers at Pacific Investment Management Co., which runs the world’s biggest bond fund, and BlackRock Inc., the world’s largest money manager with $3.7 trillion in assets, to buy Spanish and Italian debt.
“The ECB has provided much greater stability and has clipped the tail-risk of an imminent downward spiral across the euro zone,” Andrew Balls, the London-based head of European portfolio management at Pimco, said in an interview with Guy Johnson on Bloomberg Television’s “The Pulse” on Dec. 19. “That’s a real, significant positive.”
An increase in Spanish or Italian yields would represent a buying opportunity for Pimco, he said.
Spain’s bonds were still the euro area’s third-worst performers in 2012, according to the Bloomberg/EFFAS bond indexes, gaining 6.2 percent. German securities, Europe’s benchmark government debt, had the lowest return at 4.5 percent, followed by the 5.8 percent gain for Dutch securities.
Spanish 10-year yields fell to 5.26 percent on Dec. 28, down from a euro-era high of 7.75 percent reached on July 25. Prime Minister Mariano Rajoy said on Dec. 14 the nation won’t lose access to debt markets and doesn’t need to trigger the ECB support by asking for financial aid at the moment.
“We expect Spain to request a bailout program in early 2013,” Maxime Alimi, a Paris-based euro-area economist at Axa Investment Managers, wrote in the firm’s yearly outlook, published on Dec. 13. Elections in Italy in February, and in Germany in September, will ensure politics is “in the spotlight,” he wrote.
Ten-year Italian yields fell 261 basis points, or 2.61 percentage points, last year to 4.5 percent. The rate ranged between 4.35 percent and 7.18 percent.
Spanish and Italian debt was boosted in the first two months of the year after the ECB lent 1 trillion euros ($1.3 trillion) to banks via two so-called Longer-Term Refinancing Operations in December 2011 and February 2012, some of which was used to buy bonds. As the effect of the LTROs wore off, borrowing costs began to climb again, prompting the ECB to announce its bond-buying plan aimed at curtailing bets against the currency union.
The introduction of the LTRO “continued to provide support for non-core markets during the first few months of 2012,” said Nishay Patel, a strategist at Citigroup Inc. in London, referring to higher-yielding securities in the region. “Risks associated with a euro-area breakup have receded in the last six months.”
In the so-called core markets, Austrian, Belgian, Dutch and French securities all outperformed benchmark bunds after Germany’s 10-year bund yields dropped to a record-low 1.13 percent in June and its two-year rates fell below zero for the first time, reaching an all-time low of minus 0.097 percent on Aug. 2.
A negative yield means investors will receive less in repayments on the German securities through maturity than the amount they pay to buy them.
The extra yield investors demand to hold French 10-year bonds instead of bunds narrowed to 69 basis points, down from a 2012 high of 153 basis points set on Jan. 6. The so-called spread between Belgian and German 10-year securities was 74 basis points, down from as much as 279 basis points on Jan. 9.
The Dutch-German spread narrowed to 18 basis points from 82 on April 24, while the Austrian-German difference was 44 basis points from 162 on Jan. 6.
German 10-year yields may rise to 2.06 percent by the end of the fourth quarter 2013, according to analyst estimates compiled by Bloomberg.
Greece, which last auctioned bonds in March 2010, pushed through the biggest sovereign restructuring in history in 2012 to reduce its obligations and maintain access to rescue funds. Private investors forgave about 100 billion euros of debt in March.
The price of Greece’s 2 percent bonds maturing in February 2023, which were provided as part of the debt writedown, fell to 13.29 percent of face value in May, before climbing to 48.45 as of Dec. 28.
In December, when fresh measures were required to trim the debt load and release international aid, Greece used 11.3 billion euros of its latest loan from Europe’s bailout fund to buy back 32 billion euros of the bonds it issued in March.
Ireland and Portugal, the two other euro-region nations under international aid programs, will both return to the bond market in 2013, according to Lloyds Banking Group Plc. Ireland will probably sell 8 billion euros of securities, while Portugal may auction 6.6 billion euros, London-based strategists Achilleas Georgolopoulos and Vatsala Datta wrote in a Dec. 14 note to clients.
The remaining euro-region nations will sell about 789 billion euros of bonds this year, down 55 billion euros from 2012, they forecast.
“There are still many risks for investors to navigate going forward,” said Craig Veysey, head of fixed income at Sanlam Private Investments Ltd. in London, a unit of Sanlam Group, which oversees $72 billion. The elections in Italy and Germany may mean “politicians steer clear from further commitments” to extend euro-zone integration, he said. “Worries about Greece, Spain and Italy can come to the fore again.”