Portugal’s Bonds Drop With Spain’s Amid Espirito Santo Concern

Portugal’s 10-year bonds fell for a third day, with yields climbing to the highest level in more than three weeks, after shares tumbled in Banco Espirito Santo SA, one of the nation’s two biggest publicly traded banks.

Spanish bonds also fell, with 10-year yields paring an eighth quarterly decline, amid speculation the securities may struggle to extend gains into the second half of 2014. Bonds from Europe’s most indebted nations have led an advance in the region’s sovereign debt this quarter, as volatility dropped and investors sought higher-yielding assets after the European Central Bank unveiled an unprecedented stimulus program to support the economy.

“The selling in the Portuguese bond market today was probably driven by concerns about Espirito Santo and half-year bank-balance sheet adjustment,” said Soeren Moerch, head of fixed-income trading at Danske Bank A/S in Copenhagen. “We see any selloff as an opportunity to buy as we are still positive about this market.”

Portuguese 10-year yields rose nine basis points, or 0.09 percentage point, to 3.65 percent at 4:45 p.m. London time after touching 3.68 percent, the highest since June 5. The 5.65 percent security due in February 2024 dropped 0.77, or 7.70 euros per 1,000-euro ($1,369) face amount, to 115.935. The rate increase pared this quarter’s decline to 43 basis points.

Banco Espirito Santo’s shares lost 17 percent today in Lisbon trading after Bank of America Corp. downgraded the lender’s bonds. That extended an 11 percent slide on June 27.

Market Value

The declines sent the bank’s market value, until today the highest among the nation’s publicly traded lenders, almost as low as that of its closest rival, Banco Comercial Portugues SA.

Portuguese Finance Minister Maria Luis Albuquerque said last week she “doesn’t see any reason” for the government to “fear problems of financial stability” at Espirito Santo.

“So far the banking sector has not been an issue for Portugal,” said Alessandro Giansanti, senior rates strategist at ING Groep NV in Amsterdam. “However, we have seen in other countries how investors are sensitive to this topic. There is some risk that the government of Portugal will have to inject capital in the bank and that it won’t be an isolated case. Hence, the Espirito Santo story can create further tension for Portuguese government bond spreads.”

Yield Spread

The yield difference, or spread, between Portuguese 10-year bonds and German bunds, widened 10 basis points to 2.41 percentage points today. The spread, which climbed above 15 percentage points in 2012, dropped to 1.93 percentage points on June 11, the least since May 2010, according to closing-price data.

The yield on Spanish 10-year bonds rose two basis points to 2.66 percent today. The rate has dropped 57 basis points since March 31, after touching a record low 2.54 percent on June 10.

“Low volatility and expectation that the ECB will ease policy further have supported carry trades in the euro-region government bonds market,” said John Stopford, head of fixed income at Investec Asset Management in London. “That has benefited peripheral bonds. We think a lot of good news is already in the price and are not sure if the outperformance will be this strong in the second half of the year.”

Deposit Rate

European bonds returned 3 percent in the second quarter through June 27, according to Bloomberg World Bond Indexes, set for the fourth straight quarter of gains. Greece’s bonds led the advance, handing investors a 4.4 percent return, followed by Ireland’s which added 4.3 percent. Italy’s bonds rose 3.6 percent while Spanish securities advanced 3.4 percent.

The ECB this month cut its deposit rate to minus 0.1 percent, lowered the main refinancing rate to a record 0.15 percent, and announced a further package of unconventional measures to boost growth. The rally in bonds was stoked when central bank President Mario Draghi signaled at least another 2 1/2 years of subdued interest rates. ECB policy makers next meet on July 3.

Italy’s 10-year bond yield had a quarterly drop of 45 basis points. The rate touched a record-low 2.69 percent on June 9. Bank of America Corp’s Market Risk Index closed at minus 1.31 on June 26, matching the lowest level since at least 2000. It was at minus 1.30 on Friday.

German bonds rose today as a report showed the euro-area inflation rate held steady in June at less than half the central bank’s target.

Consumer prices grew 0.5 percent in the year, equaling May’s increase, the European Union’s statistics office in Luxembourg said today. That matched the median forecast in a Bloomberg News survey of 35 economists.

German 10-year yields fell two basis points to 1.25 percent, having dropped 32 basis points since March 31.

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