German Bonds May Fall as European Stress-Test Results Boost Risk Appetite
German government bonds may fall after stress-test results for European banks showed most lenders have sufficient capital to withstand a recession and sovereign- debt crisis.
Seven European Union banks failed the region’s stress tests with a combined capital shortfall of 3.5 billion euros ($4.5 billion), according to the Committee of European Banking Supervisors, which coordinated the initiative. The study scrutinized 91 lenders assuming losses of 23.1 percent for Greek debt, 12.3 percent on Spanish bonds and a 20 percent slump in European equities in both 2010 and 2011.
“We’re over a big stumbling block for the market so you might get an unwinding of flight-to-quality flows and a softer tone for bunds in the short term,” said Sean Maloney, a fixed- income strategist at Nomura International Plc in London. “The capital requirements that came out were less than expected. You’ll have your doubters but the overall result is probably a positive for the market,” damping demand for bunds, he said.
German 10-year bonds fell last week, sending the yield 12 basis points higher to 2.72 percent. The market closed before the results of the bank tests were released. U.S. 10-year Treasuries ended lower, while the euro rose 0.1 percent to $1.2909, trimming its first weekly decline in four.
Hypo Real Estate Holding AG, Agricultural Bank of Greece SA and five Spanish savings banks have insufficient reserves to maintain a Tier 1 capital ratio of at least 6 percent in the event of a recession and sovereign-debt crisis, lenders and regulators said July 23. The banks that failed the stress tests are in “close contact” with national authorities over how they will raise capital, said the CEBS, which ran the assessments.
While Europe’s stress tests provided transparency, “the longer-term themes haven’t changed,” said Nomura’s Maloney, citing concern that government austerity measures implemented to reduce budget deficits in the region may dent economic growth.
“There are numerous elements of the test that we would have preferred to have done differently,” Andrew Sheets, head of European credit strategy at Morgan Stanley in London, said on a conference call yesterday. “Where we are left we think is a scenario that is passable. It is not great, it is a slight positive.”
U.S. examinations last year set the stage for bank stocks to rally 36 percent in the following seven months.
Europe’s debt crisis was triggered after Greek Prime Minister George Papandreou’s socialist Pasok party won elections in October and said the country’s deficit was more than 12 percent of gross domestic product, twice the previous government’s estimate. That sparked a surge in bond yields as Standard & Poor’s and Moody’s Investors Service cut the nation’s credit rankings to below investment grade. Yields on so-called peripheral nations’ debt, including Spain and Portugal, climbed and German yields slid as investors favored the safest assets.
The Stoxx 600 Banks Index dropped 4.7 percent this year, led by Greek lenders, amid speculation holdings of European sovereign debt may leave institutions with inadequate capital to withstand a recession and tumbling bond prices.
Greece abandoned attempts to auction bonds in April and turned to the European Union and Washington-based International Monetary Fund as the yield on its two-year notes soared to almost 19 percent. Spanish borrowing costs reached a two-year high at a sale of five-year notes on May 6 after S&P cut the nation’s credit rating amid concern that plans to address the budget may not be fulfilled.
The yield premium, or spread, investors demand to hold Greek 10-year bonds instead of benchmark German bunds widened to a record 965 basis points on May 7.
Bond yields in the peripheral nations and spreads with bunds began to retreat after the EU and the IMF announced an aid package worth almost $1 trillion on May 10, easing concern governments in the region would default.
“The fact that only seven banks failed suggests that maybe the assumptions weren’t too tough,” said Chiara Cremonesi, a strategist at UniCredit SpA in London. “Yields are already at the lower end, but this should be moderately positive for bunds. Investors will probably remain cautious.”
German debt returned 6.3 percent this year, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Greece’s bonds handed investors an 18 percent loss in the period and Spanish securities were little changed, the indexes showed. The euro fell almost 10 percent against the dollar this year, ending last week at $1.2909.