July 4 (Bloomberg) -- Pacific Investment Management Co. and Deutsche Asset & Wealth Management are counting on the policy Mario Draghi reaffirmed yesterday to underpin peripheral bonds for the rest of the year. They’re not alone.
Irish and Greek government securities beat their European peers in the second quarter with returns of 4.2 percent and 4 percent, respectively, followed by a 3.6 percent gain from Italy, according to Bloomberg’s World Bond Indexes. Even German debt, the euro region’s worst performer, advanced 2.2 percent, supported by the European Central Bank president’s strategy.
“The fundamentals of these countries are slowly improving and we believe there will continue to be policy support from the European Central Bank when necessary,” Claus Meyer-Cording, a Deutsche Asset money manager in Frankfurt who helps manage 934 billion euros ($1.27 trillion), said by telephone. “Peripheral bonds have come a long way in terms of gains, but we remain moderately overweight” these bonds.
Investors are bullish even as the gains are tempering.
While Greek bonds advanced in the past five quarters, last quarter’s return was the lowest. The extra yield investors demand to hold the securities instead of benchmark German bonds dropped to the least in more than four years last month.
Italy’s gain was the lowest in three quarters. Portuguese bonds returned 2.7 percent compared with 12.2 percent in the previous three months.
That doesn’t deter the two money managers with combined assets of more than $3.21 trillion from retaining their overweight positions on bonds such as Italy’s and Spain’s. That means they own more securities compared with the weighting in benchmarks.
With bond yields and volatility hovering close to record lows, investors are seeking higher returns by adding riskier assets, particularly bonds from euro-region’s most indebted nations. Investors have returned to the region’s fixed-income, currency and derivatives markets as the sovereign-debt crisis that nearly broke the euro a few years ago shows signs of fading after ECB’s Draghi pledged in July 2012 to do whatever it takes to safeguard the monetary union.
Buying Italian bonds on July 26, 2012, for example, would have earned investors 32 percent compared with a loss of 1.7 percent from U.S. Treasuries.
Draghi yesterday reiterated that he will keep interest rates low as officials try to revive the region’s economy with a new round of stimulus.
While some economic data from member countries showed signs of improvement, the growth rate in the 18-nation euro region is forecast by analysts in a Bloomberg survey to be at 1.1 percent this year, less than half of the pace in 2007 before the financial and debt crisis started.
A sluggish economic recovery and persistently slow inflation prompted the ECB president and his officials to introduce a range of measures last month. The Frankfurt-based central bank cut its benchmark interest rate to a record-low 0.15 percent, took its deposit rate below zero and unveiled targeted loans to help revive lending and growth.
Governments will report the euro-zone economy expanded by 0.3 percent in the second and third quarters, and will accelerate to 0.4 percent growth in the final three months of the year, according to a Bloomberg survey of economists.
With inflation at less than half the ECB’s target of just below 2 percent for a ninth month, Draghi has prepared investors for the prospect of further action should the threat of a negative price spiral remain.
“Inflation is still very weak, and we think it will go lower,” Andrew Balls, deputy chief investment officer at Pimco in London, said by phone. “There’s a potential for the ECB to do large-scale asset purchases which could lead to further spread tightening. While yields are low, the carry advantage versus the core bonds is still attractive.”
Pimco has an overweight position on Italy’s, Spain’s and Slovenia’s government bonds. Balls said he sees a 50-50 chance that the ECB will adopt a quantitative-easing program.
While the 10-year Portuguese bond rate dropped to 3.23 percent on June 10, the lowest since September 2005, it still offered a yield pickup of 193 basis points over German bunds at a market close on that day, compared with an average of 22 basis points in the three years before the debt crisis erupted in 2009. The spread was 230 basis points yesterday.
Peripheral bonds will also be supported by a brighter credit-rating outlook, according to Rabobank International.
The economic future has improved from countries that were at the heart of Europe’s sovereign debt crisis. Standard & Poor’s updated Ireland’s credit rating by one level to A- last month, saying the strengthening economy will help the government reduce its debt.
It also raised Spain by one rank, to BBB, the second-lowest investment grade, in May. Fitch Ratings increased Greece’s long-term grade by one step to B. That’s still five rungs below investment grade.
“The ratings outlook is in a positive feedback loop,” said Lyn Graham-Taylor, a fixed-income strategist at Rabobank in London. “The very low financing cost is feeding through into lower bond issuance. That, and expectations that the ECB will do more, will keep the spread-tightening momentum going.”
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