Berlusconi Long Yields Penalized Before 30-Year Debt Auction: Euro Credit
Prime Minister Silvio Berlusconi’s longest-term bonds yield almost as much as Spain’s even though Italy’s deficit is less than half, a sign Europe’s debt crisis has created relative bargains for fixed-income investors.
Italy, which plans to sell as much as 2 billion euros ($2.8 billion) of 30-year securities tomorrow, is being penalized with interest rates of 4.7 percent for the bonds, just below Spain’s 4.9 percent. Italy’s 30-year debt yields 1.8 percentage points more than comparable German bunds.
Italian bonds rose more than 1 percent in the past month as investors bet the country will cut its deficit faster than other so-called peripheral nations that also suffered a surge in borrowing costs following Greece’s near default in May. Italy’s economy is growing, helping reduce a budget gap that stands at 5.3 percent of gross domestic product, or less than half that of Spain, Ireland and Greece.
“I don’t see what the risk is in Italy,” said Steve Mansell, director of interest-rate strategy at Citigroup Inc. in London. “If investors are still minded to search for yield, then Italy is probably a prime choice.”
Italy is auctioning 30-year bonds following gains in short- term debt after the Federal Reserve signaled it may take emergency steps to shore up the U.S. economy. The advance steepened the yield curve, or difference of short- and long-term bond yields. The spread between 10- and 30-year Italian bonds rose to 98 basis points from 82 basis points at the start of last month. The difference between two- and 10-year bonds rose 14 basis points to 304 basis points in the same period.
“We see Italian 30-year debt as representing the best value among the ultra-long bonds being sold this week,” said Padhraic Garvey, head of developed market strategy at ING Groep NV in Amsterdam, referring to auctions by the Netherlands, Japan and the U.S. “Italian bond spreads were dragged higher because it’s seen as part of the peripheral market, and yet their fundamentals are stronger than Spain, Ireland or Portugal.”
The Netherlands yesterday sold 1.8 billion euros of bonds due 2042. The securities were priced to yield 2.913 percent, or almost 200 basis points less than similar-maturity Italian debt. Japan will sell 600 billion yen ($7.3 billion) of 30-year bonds tomorrow, followed by the Italian sale and the auction of $13 billion of U.S. Treasury bonds due 2040.
Given the lingering concerns about European debt and deficit levels, the relative value of 30-year Italian bonds to other debt on offer may not last.
“Our view is it’s probably a bit too early to say things are okay in the peripheral markets and Italian bonds will outperform across the board from here,” said Peter Schaffrik, head of European interest rate strategy at Royal Bank of Canada Europe Ltd. in London.
The International Monetary Fund raised its forecast this month for Italy’s 2010 economic growth to 1 percent from 0.9 percent, while predicting a 0.3 percent contraction for Spain.
Italian unemployment fell for a third month in September to 8.2 percent, compared with 13.7 percent in Ireland, 10.6 percent in Portugal and 20.1 percent in Spain, the highest in the euro region.
Italy’s debt was the largest in the euro region at 115.9 percent of GDP last year. It’s forecast to rise less than 3 percentage points this year. Greece’s debt load will jump to 130 percent from 115 percent to overtake Italy in 2010.
Demand for Italian bonds may also be damped in the near term after European Central Bank Government Governing Council member Axel Weber said the ECB should stop its bond-purchase program, threatening to remove a lifeline for European governments and banks trying to shore up their finances.
“Without the ECB’s bond buying acting as a backstop on yield spreads, any strong selling activity could push spreads back out to danger levels, discouraging further buying from real money investors,” said Peter Chatwell, a fixed-income strategist at Credit Agricole Corporate & Investment Banking in London. “That’s an event risk for peripheral countries.”
Spain’s deficit will boost its debt by almost 10 percentage points to 62.8 percent in 2010. Portugal has forecast its debt will climb by more than 7 percentage points to 83.5 percent.
Italy’s inflation rate of 1.8 percent is less the European Central Bank’s 2 percent target for the euro region, easing concern that rising prices will erode the value of the country’s long-term bonds. The Italian 30-year breakeven rate, a gauge of inflation expectations, was 212 basis points, down from a high of 279 basis points on May 19. The rate is derived from a spread between nominal and index-linked bonds of the same maturity.
‘Shift in Favor’
Italian bonds with maturities of more than 10 years gained 1.2 percent in the past month, better than similar debt from AAA-rated issuers such as the U.S. and Netherlands.
“We’ve seen a bit of a shift in favor to the periphery over the last few sessions,” said Sean Maloney, fixed-income strategist at Nomura International Plc in London. “We might see some decent interest in Italy on the yield basis.”
Italian 30-year bonds are the cheapest among similar maturity debt on sale this week on a so-called asset-swap basis, ING’s Garvey said. If investors swap the fixed rate offered by the bonds into a floating rate, the security yields 190 basis points over libor, compared with 18.5 basis points for its Dutch counterpart and 7.2 basis points for Japanese bonds.
“Our in-house model suggests 30-year Italian bonds are offering around 100 basis points more than it should,” Garvey said. “The bond is undervalued.”