Bunds Show True Cypriot Backlash as Italy Insulated
With the yields of the euro area’s most-indebted nations getting support from the European Central Bank, the region’s safest bonds are proving the best indicator of risk amid turmoil in Cyprus.
While Spanish and Italian bonds weathered events from Cyprus over the past 11 days, yields on German securities, along with those of French, Austrian and Belgian debt, fell as investors sought haven assets. The rate on two-year German notes fell below zero on March 18 for the first time since Jan. 2, while Austria’s 10-year yield dropped to a record on March 22.
“Overall, the market seems to be very confident in the ECB,” said Michael Leister, an interest-rates strategist at Commerzbank AG in London. “The safety bid will remain in place given that the market is now aware that policy risks have increased yet again, which will keep bunds underpinned.”
German government bonds advanced yesterday after Cypriot President Nicos Anastasiades agreed to shut the country’s second-largest bank, bowing to demands from creditors to shrink the banking system in exchange for 10 billion euros ($13 billion) of aid. German 10-year yields declined to 1.33 percent, the lowest since Jan. 2, while rates of Italian and Spanish securities rose. The bund yield was 1.35 percent today.
Italian 10-year yields were at 4.57 percent at 1 p.m. London time, down from as much as 4.68 percent on March 15, the day before European Union finance ministers attempted to impose an unprecedented levy on bank deposits as a condition of emergency funds to Cyprus.
Cyprus dodged a disorderly default and an unprecedented exit from the euro when the country’s lawmakers struck a deal early yesterday with international creditors for the second time in nine days, underscoring the difficulties of crisis management in the region.
The accord for the island nation paved the way for rescue loans from the so-called troika of the ECB, the European Commission and the International Monetary Fund.
ECB President Mario Draghi pledged in September to purchase bonds of struggling euro-area nations that request aid in order to cap borrowing costs in the region’s high debt and deficit economies through the Frankfurt-based central bank’s Outright Monetary Transactions program.
Spanish 10-year yields have tumbled 282 basis points from a euro-era record 7.75 percent reached the day before Draghi said July 26 that he would do “whatever it takes” to support the euro. The rate on equivalent-maturity German bunds rose 12 basis points in the same period.
“It remains to be seen how the Cyprus situation plays out, but the near-term dangers aren’t significant enough to outweigh the spread tightening on the back of the ECB,” said John Wraith, a fixed-income strategist at Bank of America Merrill Lynch in London. “As always, Germany is the main beneficiary of safe-haven flows. The ECB’s commitment made last summer is still putting a backstop under periphery bonds.”
The promise of an OMT backstop has helped push Italian yields lower than before the nation’s inconclusive elections on Feb. 24-25. The 10-year rate slid to a one-month low of 4.43 percent yesterday even as lawmakers in Europe’s biggest debt market struggle to form a government and the nation’s 18-month recession drags on. The yield was as high as 6.71 percent on July 25.
“The market reaction has been very muted,” said Michael Riddell, a London-based fund manager at M&G Group Plc, who helps oversee about $370 billion. “The market continues to underplay not just Italian political risk but euro zone political risk generally, and I’m still not touching peripheral euro zone sovereigns at these levels.”
German bunds have handed investors a 0.7 percent return this month through yesterday, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Italian bonds earned 0.9 percent and Spanish securities gained 0.6 percent.
Banks in Cyprus, which have been shut for the past week, will remain closed through tomorrow, the central bank said. Cypriot lawmakers voted last week to impose capital controls to prevent a run on deposits when they reopen.
Dutch Finance Minister Jeroen Dijsselbloem, who heads the group of euro-area finance chiefs, said yesterday that the Cypriot rescue plan may become a template for euro-area bank bailouts, fueling concern about the security of deposits across the region.
“Banks should basically be able to save themselves, or at least restructure or recapitalize themselves as far as possible,” Dijsselbloem said in an interview with Reuters and the Financial Times. “It will force all financial institutions, as well as investors, to think about the risks they are taking on because they will now have to realize that it may also hurt them.”
Nobel laureate Christopher Pissarides, the head of Cyprus’s economic policy council, told Bloomberg Television that yesterday’s agreement was “disastrous” and risks undermining confidence in euro-area banks.
“It is a bit of a conundrum as it is difficult to imagine that there won’t be any broader contagion effects under the various scenarios,” said Elwin de Groot, a market economist at Rabobank Nederland in Utrecht, the Netherlands. “It seems market participants have kept their composure, but that would be largely on the credibility of the ECB’s promise to do whatever it takes.”