AAA Yields at Zero Drive Investors to Belgian Debt: Euro Credit

Belgian flag outside the EU Parliament building
The Belgian national flag flies at half mast, outside the European Parliament building. (Photo by Herman Ricour /Getty Images)

Investors are relinquishing the sanctuary of AAA bonds as yields near or below zero on German, Dutch and Finnish debt drive them to seek higher returns on Belgian and French securities.

“Investors may seek security, but not at all costs,” said Johannes Jooste, a senior strategist at Merrill Lynch Wealth Management in London, which oversees $1.8 trillion globally. “Longer-term investors are looking at yields and thinking what possible gain is there in essentially paying some governments to look after their cash. The default risk in some countries like France, Belgium and Austria must be fractionally different from Germany if you take a long-term view.”

Belgian securities, rated AA by Standard & Poor’s, are the top government bond performers this month, handing investors a 3.2 percent return relative to a 2 percent gain for German debt. Austrian bondholders made 2.6 percent, beating Finnish debt’s 2.1 percent advance. The extra yield investors demand to own 10-year French debt rather than German bunds has narrowed to 102 basis points from 139 at the start of the year.

German, Dutch and Finnish yields have dropped to records as Europe’s three-year old debt crisis spurred demand for the highest-rated securities. Investors accept a negative yield of 0.052 percent on German two-year notes, paying for the comfort of getting most of their capital repaid in 2014.

Italy became the latest euro member to be downgraded after Moody’s Investors Service today cut the nation’s bond rating by two steps to Baa2 from A3 and said further reductions are possible. That makes Italy’s rating the same as those of Kazakhstan, Bulgaria and Brazil, according to data compiled by Bloomberg.

Cutting Deposits

Banks in the 17-nation euro region more than halved their deposits at the European Central Bank, according to figures released yesterday. They parked 324.9 billion euros ($396.6 billion) with the ECB on July 11, down from 808.5 billion euros the previous day and the least since Dec. 21. That’s after the central bank cut its deposit rate to zero this month.

The yield on German two-year notes fell to a record minus 0.052 percent today, 9 basis points below Austrian two-year securities and 38 basis points less than Belgian debt of similar maturity. A negative rate means investors who hold the debt until expiry will receive less than they paid to buy.

“We are not sure if Germany deserves a level of discount in the market that it has,” said John Stopford, the London-based head of fixed income at Investec Asset Management, which oversees $98 billion. “Our view is that Germany will ultimately have to pick up the bill.”

Nissay Asset Management Corp., which manages the equivalent of $69 billion, has reduced holdings of short- and medium-term German debt and increased stakes in AA rated notes, according to Shinji Kunibe, its Tokyo-based chief portfolio manager of fixed-income investment.

Zero Bound

Investors have pushed yields on AAA bonds, both inside and outside of the euro region, to record lows. Finnish two-year borrowing costs fell to a record yesterday, while Denmark sold two-year notes at a negative yield on July 3 for a second time in as many weeks. The yield on five-year Swiss bonds dropped below zero for the first time in May.

European leaders remain divided over how to solve the crisis as the outlook for economic growth dims. Italian Prime Minister Mario Monti and French President Francois Hollande advocate bonds backed by all 17 members of the currency, while German Chancellor Angela Merkel opposes the plan.

France, which was stripped of its AAA ratings by Standard & Poor’s in January, had zero growth in the first quarter while joblessness is rising. In Belgium, the central bank forecast the economy will contract 0.1 percent this year. Business confidence fell to the lowest in 2 1/2 years last month, while corporate bankruptcies rose in the first half of this year.

Not all investors are convinced a 100 basis-point yield premium on French debt makes them worth buying.

Binary Risk

“Ultimately, these bonds are vulnerable,” said Mark Dowding, a senior portfolio manager at Bluebay Asset Management which has $41 billion in assets. “If the problem in the euro zone is fixed, they are unlikely to outperform Italian or Spanish debt. If the euro stays broken, their current outperformance is unjustified.”

Deutsche Bank AG, Germany’s biggest lender, recommends investors buy five-year French bonds even as it describes the country as “the weakest link.” The securities yield 62 basis points more than five-year German notes. The bank also favors similar-maturity debt from the Netherlands, Austria and Belgium.

“These countries may have their own problems and challenges, but overall they are relatively safe,” said Mohit Kumar, the head of European interest-rate strategy at Deutsche Bank in London. “There’s plenty of cash in the market and it needs to be parked somewhere. You might as well do it where you get some returns. It doesn’t make a lot of sense to buy German debt at current levels.”

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