Rajoy Rewarded as Spanish Shed Discount to Italians
Investors are backing Spanish politicians for the kind of austerity measures their counterparts in Italy are finding elusive.
Spain has paid three basis points less than Italy over the past two months to borrow for 10 years compared with the average 41 basis-point premium it was charged in the first eight months of 2013, data compiled by Bloomberg show. The Spanish yield fell below 4 percent at the end of October for the first time in almost six months and stood at 4.07 percent on Nov. 15, compared with 4.09 percent for Italian securities.
“Greater commitment to a reform agenda favors Spain over Italy,” Michael Michaelides, a London-based strategist at Royal Bank of Scotland Group Plc, said by telephone. “Spain is regaining competitiveness faster than Italy.”
In power since 2011 with a majority, Spanish Prime Minister Mariano Rajoy led the economy to growth this year amid the deepest budget cuts in the country’s democratic history. Enrico Letta, Italy’s third premier since Rajoy took office, is struggling to guide his country out of a recession that figures showed last week had entered its third year.
The trend in the bond market changed in September over concern that Letta’s government may collapse. Michaelides said he expects Spanish 10-year yields to drop to 3.5 percent. That would make them similar to Ireland, which is exiting its bailout program next month after three years of emergency loans.
Morgan Stanley strategists including Anton Heese wrote in a Nov. 8 note that investors should buy Spanish 10-year bonds and sell Italian debt. They see the spread widening to a percentage point, a level last seen in January 2012.
“Italy hasn’t carried out enough austerity measures and is at risk of a credit-rating downgrade in the next six months,” Tanguy Le Saout, who helps oversee about $227 billion at Pioneer Investment in Dublin, said in a Nov. 8 telephone interview.
By contrast, Standard & Poor’s and Moody’s Investors Service will probably follow Fitch Ratings in lifting their outlook for Spain as economic activity picks up, Le Saout said. S&P and Moody’s both rate Spain, which lost its AAA status in 2009, at the lowest investment grade.
Fitch affirmed its rating at BBB, one step higher, on Nov. 1 and raised its outlook to stable from negative citing budget cuts achieved since 2012 and “significant reforms” of the labor market, pension system, fiscal framework and financial sector. “The effort made to date should put the economy on a surer footing,” the firm said.
S&P confirmed Spain’s rating in June, a month before it cut Italy’s to BBB. The company cited weaker growth and budget targets that are “potentially at risk.”
Letta, 47, is trying to shift the burden of budget cuts to focus on government bureaucracy and away from taxpayers after his predecessor, Mario Monti, counted mainly on tax increases to shield Italy from bond-market speculation.
So far, measures have failed as lawmakers remain preoccupied with preserving the three-party coalition. Italy’s debt, which broke the 2 trillion-euro mark a year ago, will surge to 134 percent of GDP next year, the most in Europe behind Greece, according to forecasts by the European Commission.
The euro region’s third-largest economy contracted for a ninth quarter in the three months through September, extending the longest slump since World War II, as export growth failed to offset the impact of rising unemployment on domestic demand.
Spain emerged from a recession in the third quarter, helping push down the second-highest jobless rate in the European Union. Unemployment fell to 26 percent last quarter from 26.3 percent, the highest level since at least 1976, the year after dictator Francisco Franco’s death.
Rajoy, 58, expects to stabilize Spain’s debt load around 101 percent of GDP from 2015 as a 1.3 percent economic contraction this year gives way to 0.7 percent growth in 2014, according to government forecasts. The country is likely to meet its deficit target of 6.5 percent of GDP this year, Budget Minister Cristobal Montoro said on Sept. 30.
Spain is on course for a “clean break” in January from the rescue loans it secured last year, Economy Minister Luis de Guindos said on Nov. 14. The country took 41 billion euros in aid to help its banking industry cope with the legacy of a collapse in the real-estate market.
“We should see a continued underperformance of Italy versus Spain,” said Richard McGuire, head of rates strategy at Rabobank International in London. “In the medium term, decoupling will be driven by Spain’s going down the Irish route while political issues, lack of reform progress and possible negative rating actions weigh on Italian bonds.”