Aug. 7 (Bloomberg) -- Spanish government bonds have returned almost twice as much as Italy’s this year, reflecting investor bets that Spain’s recovery from recession will outstrip the moribund Italian economy.
What’s more, with both countries’ governments embroiled in political turmoil, Spanish Prime Minister Mariano Rajoy’s parliamentary majority probably will enable him to ride out corruption allegations, according to analysts, including Elwin de Groot of Rabobank Nederland in Utrecht, the Netherlands.
Ten-year Spanish bond yields dropped to the lowest level in six weeks on Aug. 5 as evidence of a nascent recovery in the euro region bolstered demand for higher-yielding assets. The bonds also rallied after European Central Bank President Mario Draghi said last month that interest rates will remain low for an “extended period” to support the economy.
“We currently favor Spain over Italy and we think the outperformance can continue,” said Russel Matthews, a money manager at BlueBay Asset Management in London, which oversees $56 billion. “The fundamental picture in Spain is likely to improve more than in Italy. The economy is slightly more dynamic and has a better chance of taking off.”
While BlueBay holds more Spanish and Italian bonds than the benchmark it uses to track performance, the firm prefers to express its positive views on Europe’s high debt and deficit nations by buying Spanish securities, Matthews said.
The Bloomberg Spain Sovereign Bond Index was up 6.8 percent this year as of yesterday, compared with 3.9 percent for an equivalent index of Italian bonds. German securities, the region’s benchmark, lost 1.5 percent.
Spain’s 10-year rate was little changed at 4.57 percent as of 3:45 p.m. London time after sliding to 4.54 percent on Aug. 5, the lowest level since June 19. The yield was 5.27 percent at the start of the year. Italy’s 10-year yield is 4.26 percent, while Germany’s is 1.68 percent.
The 10-year Spanish yield is down 70 basis points, or 0.7 percentage point, this year, compared with a 24 basis-point drop for the rate on similar-maturity Italian bonds.
Spanish borrowing costs slid as Rajoy defended himself in parliament last week against demands he resign over allegations he received undeclared funds from a party slush pool.
Rajoy denied any wrongdoing, telling parliament in an extraordinary session in Madrid on Aug. 1 that he’d “made a mistake in continuing to trust someone who we now know didn’t merit it.” He was referring to the former treasurer of his People’s Party, Luis Barcenas, who has named Rajoy among officials who allegedly received payments from a secret fund.
“The market is reacting to the political uncertainties,” said de Groot, who’s a senior market economist at Rabobank. “What it is signaling is that they still have quite some confidence that the current government will stay in place. In that case, the government can continue the reforms and stabilize the economic situation.”
With the ECB’s benchmark rate at an all-time low of 0.5 percent, economic data suggest the currency bloc is starting to emerge from a record-long recession. Draghi said last week that recent indicators signal the region is past the worst of the slump and data “tentatively confirm the expectation of a stabilization in economic activity.”
In Spain, data released two days ago showed services output shrank at a slower pace than initially estimated in July, while a report last month showed the nation’s recession eased in the second quarter. Gross domestic product fell 0.1 percent in the first quarter, the Madrid-based National Statistics Institute said. Italy’s GDP contracted 0.2 percent in the three months through June, according to a report released yesterday.
‘Period of Recovery’
“The Spanish economy is leaving the recession behind,” Economy Minister Luis de Guindos told lawmakers in the Spanish capital on July 25. “We are close to a period of recovery in which it’ll be key to deepen reforms in order to avoid a false recovery as happened in 2010.”
Spain’s economy will probably contract 1.6 percent this year, while Italy’s will shrink 1.8 percent, according to analysts’ estimates compiled by Bloomberg. Euro-region GDP will decline 0.6 percent, a separate survey shows.
Challenges remain, Rabobank’s de Groot said, including the risk that growth may disappoint investors and that the political turmoil may intensify. Spain must go further to increase the flexibility of its labor market to put a dent in its 26 percent unemployment rate, the International Monetary Fund said last week.
Investors snapped up Spanish securities as the nation sold more bonds last week than its maximum target as borrowing costs fell. The nation’s Treasury said it has covered 73 percent of its mid- and long-term gross funding needs for this year.
“Spain has taken care of its funding plan, and that reassures investors that if it does reach a hard patch, it will be able to cope,” said David Schnautz, a fixed-income strategist at Commerzbank AG in New York. Ten-year Spanish yields may slide to 4.40 percent by the end of August, he said. The rate was last at that level on May 31.
“There are signs the economic situation is getting better,” Schnautz said. “Yields have the potential to go lower.”
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