Worst Performing Bonds in Euro Region Still Have Room to Fall

  • Portuguese market loses more than anywhere else in past month
  • Political standoff reminds Milan investors of Italy in 2013

As politics in Portugal makes the country’s bonds the worst performers in the euro region, money managers in Italy are being reminded of their own stalemate and have a warning: it’s still too early to buy.

Lauded as southern Europe’s beacon of stability after completing its international bailout package last year, the gloss has come off Portugal in the month since Prime Minister Pedro Passos Coelho won re-election though without a parliamentary majority. The extra yield, or spread, that investors get for holding Portuguese 10-year bonds instead of Italian peers climbed above 100 basis points for the first time since February and reached the widest in eight months versus their Spanish peers.

Viewed from Milan, the plight of the Portuguese debt market looks reminiscent of Italy two years ago after an inconclusive election. Coelho will present a plan to parliament next week for a minority government and should he fail to win enough support, the president will have to seek a new prime minister.

“Portugal is still struggling to form a government -- it’s like Italy in early 2013 -- so there is a premium in the market,” Luca Noto, a senior fund manager at Anima Sgr Spa, which managed about 65 billion euros ($71 billion) as of July 31, said in an interview in Milan. “We’re not yet a buyer, but we are close to the buying area.”

Laggards

Portuguese bonds lost 1.6 percent in the past month, compared with gains of 0.5 percent and 0.3 percent for Italian and Spanish peers, according to Bloomberg World Bond Indexes. That’s even as expectations of the European Central Bank extending its bond-buying program, or quantitative easing, spurred the market. Ten-year yields jumped 32 basis points, or 0.32 percentage point, since Oct. 2, the last trading day before the election.

The extra yield over Italian securities with a similar due date was at 93 basis points on Friday, after reaching 106 points on Oct. 30, the most since Jan. 21 based on closing prices. They yielded 79 basis points more than their Spanish counterparts, up from 52 points on Oct. 2.

The question of who will run the country needs to be answered before those moves can be reversed, said Paolo Bernardelli, head of the fixed-income and foreign exchange team at Eurizon Capital SGR in Milan. Socialist Party leader Antonio Costa has said he could form a stable government with the Left Bloc and Communist Party, raising the possibility of Coelho’s administration collapsing.

“Once political problems are resolved, Portuguese bonds could resume their narrowing in the spread against core countries,” said Bernardelli, whose team oversees about $55 billion of investments.

Italian Experience

Italian bonds were hobbled by politics after an election in February 2013. The standoff was resolved with the appointment two months later of the Democratic Party’s Enrico Letta to lead a broad-based government. During that time, Italy’s 10-year yield spread over German bonds reached a three-month high of about 360 basis points. It was less than 100 basis points last week.

With a market equivalent to about a 10th of Italy’s, the fourth largest in the world, Portuguese bonds have also been constrained by a relative lack of liquidity, which makes the securities more susceptible to sudden price swings.

On average, the difference between the highest and lowest yield on Portugal’s 10-year bonds has been 29 basis points on a weekly basis this year, compared with 21 basis points for Italian bonds and 15 basis points for benchmark German 10-year bonds.

“Portugal still should trade above Spain and Italy -- but maybe below 100 basis points,” said Noto. “It’s about the premium you want to see before entering the market, not just because of political risk but also, the liquidity risk that is still there.”

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