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Scottish Investors Shun Spanish Bonds Even at 5.5%: Euro Credit

Aberdeen Asset Management Head of Strategy Mike Turner
Head of strategy at Aberdeen Asset Management in Edinburgh Mike Turner said, “There is a lot of doubt still about the sustainability of finances among some of the peripheral governments.” Source: Aberdeen Asset Management Plc via Bloomberg

Spanish bond yields, approaching their highest level in eight years, still don’t offer enough reward to tempt fund managers 1,000 miles north in Scotland.

The yield on 10-year Spanish debt rose 1.52 percentage points to 5.52 percent in the past two months as investors speculated Spain might follow Greece and Ireland in needing a rescue package to avoid default. That’s about half the level available for lending to Greece for the same period.

“You should ask if any of us would buy Spanish government bonds yielding five-and-a-half percent,” Bill Dinning, head of strategy at Aegon Asset Management, said during a discussion among three investors overseeing 360 billion pounds ($557 billion) at Bloomberg’s Edinburgh office. “Probably not.”

“It’s too risky,” said Andrew Milligan, who holds the same post at Standard Life Investments.

Spanish debt prices slumped last week after borrowing costs rose at the government’s final bond sale of the year. The 10-year yield climbed more in November than in any month since at least 1993, according to data compiled by Bloomberg.

The Treasury in Madrid today sold 3.88 billion euros ($5.1 billion) of three- and six-month bills, with average yields for the latter jumping as much as 49 basis points from a month ago.

Moody’s said on Dec. 15 it might cut the nation’s Aa1 credit rating, citing “substantial funding requirements, not only for the sovereign but also for the regional governments and the banks.” The cost of insuring Spanish government debt climbed to a three-week high yesterday, with five-year contracts protecting $10 million of debt up $12,000 to $344,000 a year.

Previous Rescues

The European Union and International Monetary Fund put together a 110 billion-euro package of loans in May for Greece, crippled by government spending it struggled to finance. Ireland secured 85 billion euros last month as bank debt threatened to bring down the economy. Greek 10-year bonds yield 11.9 percent, while those in Ireland are at 8.5 percent.

“There is a lot of doubt still about the sustainability of finances among some of the peripheral governments,” said Mike Turner, head of strategy at Aberdeen Asset Management in Edinburgh. “Unless we get some more overt support now, then we think markets are going to come back again.”

EU leaders approved on Dec. 17 a permanent crisis-management facility from 2013. Leaders have taken “decisive action” to keep financial stability and foster economic recoveries, they said after a two-day summit in Brussels.

“The amount of action needed from the policymakers is growing each crisis,” said Milligan. “The amount to cap Greece, the amount to cap Ireland, the amount to cap Spain is going to be very different.”

Funding Woes

Spanish 10-year bonds yield about 253 basis points more than German bunds, up from a low for the year of 137 in July. “Spreads remain high by historical standards, emphasizing the need for Spain to strengthen financial-market confidence in the sustainability of government finances,” the Organization for Economic Cooperation and Development said yesterday. “If the high sovereign spreads persist, funding conditions in the private sector could be affected.”

The country needs to borrow 290 billion euros next year, including the funding needs of its central government, regional administrations and banks, which leaves it “susceptible to further episodes of funding stress,” according to Moody’s.

“It seems natural to assume that Spain is a much bigger issue in terms of the size of the country and the impact on the euro as a whole,” Turner said. “To allow spreads to get to the level of Ireland and Greece, something would have to be seriously, seriously awry.”

Australian Alternative

For now, Spanish bonds have further to fall and spreads further to widen, according to the strategists. What’s more, there’s better value outside Europe, they said.

Spain had a budget deficit of 11 percent of gross domestic product last year and the government is targeting 9.3 percent this year and 6 percent for 2011. Australia, whose currency rose to a record against the U.S. dollar on Nov. 5, is targeting a spending gap of 2.4 percent for 2011 and its 10-year bonds yield 5.52 percent.

“Why would you buy Spain at 5.5 percent when you can get a bigger yield in Australia?” Dinning said. “Do I expect the spread on Spanish debt to get to the sort of level we saw in Greece? No. There is a price at which Spanish bonds are a buy.”

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