Spanish Reap Growth Reward as Italy Hurt by Selloff: Euro Credit

Spain’s borrowing costs are lower than Italy’s by the most in more than two months, reflecting the diverging strengths of their economies after investors recoiled from the euro region’s most indebted nations.

The extra yield on Italian 10-year debt over Spanish securities reached 21 basis points today, the most since March 5. Italian bonds led declines this week, handing investors a 0.93 percent loss compared with 0.32 percent for Spanish securities, Bloomberg World Bond Indexes show.

“The yield hunt story isn’t over,” Cyril Regnat, strategist at Natixis in Paris, said by telephone today. “When you look at economic fundamentals in Europe, it makes more sense to bet Spanish bonds will rise rather than Italian ones.”

Spanish debt thrived during a four-month rally of euro-region bonds that ended last week and proved resilient to concerns over politics and monetary policy. The securities barely budged during the selloff that started in Greece ahead of elections to the European Parliament over coming days and the European Central Bank’s next rate decision.

Credit Ratings

Spain’s credit rating was raised one level to BBB today by Standard & Poor’s, which boosted its economic growth forecasts for the nation. Fitch Ratings increased Greece’s grade, which remains five steps below investment level at B, citing an improving economic outlook for the country that triggered Europe’s sovereign debt crisis.

The yield on Greek 10-year bonds fell to as low as 6.5 percent. Spanish yields dropped to 2.97 percent compared with 3.16 percent for similar Italian securities. That cost of borrowing is still more than double what Germany pays.

Polls show Prime Minister Mariano Rajoy’s People’s Party, which has implemented the deepest austerity measures in the Spain’s democratic history since coming to power in 2011, leading the Socialists in the European Parliament vote.

While Spain’s jobless rate remains the highest in the European Union after Greece, at 25 percent, its economy expanded for a third straight quarter in the three months through March, and twice as fast as the euro region average. Italy, meanwhile, reported a surprise contraction.

“There is further gain to be had with Spanish bonds,” Richard Kelly, a senior fixed-income strategist at Toronto-Dominion Bank in London, said two days ago. “Overall Spain is outperforming in an economic sense.”

Buying Derivatives

Traders last week sold debt bought on the assumption that the ECB’s next steps would support the market.

“The selloff in Spain’s bonds in the past week was not driven by its fundamentals, which are improving,” said Owen Callan, a bond analyst at Danske Bank A/S in Dublin. “Investors were looking for an excuse to take profits.”

Investors also poured into derivatives to protect against losses after they became concerned by rising support for anti-EU parties among the union’s 400 million voters.

Polls in Italy have showed lackluster support for Prime Minister Matteo Renzi, with his Democratic Party consistently in first place though often with a slender lead. In Greece, a first round of local and regional elections undermined premier Antonis Samaras’s coalition in favor of anti-bailout party Syriza.

Spanish Stability

“An extremist vote in the European election could destabilize the Italian government more than others,” said Francesco Marani, a fixed-income trader at Auriga Global Investors SA in Madrid. “That’s unlikely in Spain, which also has a smaller debt stock and is ahead of Italy in restructuring its economy and banking system.”

Spain remains the top performers among major developed markets for the year to date, with a 7 percent return. That compares with 4 percent for Germany and 5.6 percent for Italy, which has turned out to be more vulnerable to the volatility that characterized Europe’s debt crisis.

Yesterday, Spain sold five-year and 10-year debt at the lowest yields on record. The spread between its 10-year borrowing costs and those of Germany narrowed to 158 basis points today compared with a two-month high of 179 basis points on May 16. The premium for Italy was 176 basis points.

“The market differentiates between countries even as there remains a correlation between non-core sovereigns,” Vincent Chaigneau, global head of rates and foreign exchange strategy at Societe Generale SA in Paris, said in an interview yesterday. “Spain has been better at delivering reforms and remains attractive as investors’ quest for returns dominates.”

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