Europe’s Periphery Deaf to Brexit Warnings, AGI’s Riddell Saysby
Italian 10-year bond yields are too low to compensate for risk
Fitch says EU exit would weigh on economies of other members
One of the asset classes most vulnerable to the shock of Britain potentially leaving the European Union isn’t hearing the alarms, according to Allianz Global Investor’s sterling fund manager.
Peripheral euro-area government bonds are underpricing the risks of a Brexit, said Mike Riddell, the London-based money manager. Italian 10-year bond yields offered a premium of 134 basis points over similar-maturity German bunds Monday. Should Britain vote to stay in the world’s largest trading bloc, the spread could narrow to 115 basis points, but if the nation leaves, there is no limit to the potential widening, Riddell said. Betting on declines in Italian bonds is the most obvious way to trade this risk, he said.
“If the U.K. voted to leave the EU, as the second largest economy in Europe, then that does not send a good signal for the future of project Europe,” said Riddell. “If you think it’s political will that’s keeping the euro zone together then you can understand why peripheral government bonds would come under pressure. Within the fund, I don’t think you are being paid enough yield to compensate you for these risks.”
Bonds in peripheral countries of Italy, Spain and Portugal are already facing headwinds from their respective domestic solvency worries, with the banking crisis in Italy still some way from a resolution and Spain bracing itself for a second general election in six months.
The reverberations of an exit from the EU will also travel beyond the U.K.’s borders, according to Fitch Ratings. While Britain will bear the brunt of such an event, the economic impact on the rest of the region “would still be palpable,” Fitch said in a report released Monday. There was also a possibility that they could look at “negative rating actions on other EU sovereigns” if, in the medium term, the economic effect were severe and political risks materialized.
Italy’s 10-year bond yield increased two basis points, or 0.02 percentage point, to 1.49 percent as of 4:04 p.m. London time. The 2 percent security due in December 2025 fell 0.145, or 1.45 euros per 1,000-euro ($1,133) face amount, to 104.575. Benchmark German bund yields rose two basis points to 0.14 percent.
Italian bonds have been the worst performers this year among euro-area sovereign debt after their Portuguese peers, earning 1.2 percent through May 13, compared with a 4.1 percent return from German bonds and an average 3 percent on the region’s government debt, according to Bloomberg World Bond Indexes.
Riddell also said he has no positions in Europe’s peripheral corporate bonds. The 72 million-pound ($104 million) Allianz Sterling Total Return Fund that he took over management of in November is now 60 percent invested in sovereign debt with “very little” in high-yield corporate bonds, Riddell added. The Sterling Total Return Fund has returned 2.9 percent this year, beating 71 percent of peers. AGI is part of Munich-based insurer Allianz SE and manages about $500 billion.
The International Monetary Fund has warned that Britain opting to leave the EU in the June 23 vote could threaten the stability of global financial markets. IMF chief Christine Lagarde said May 13 that such an outcome is an international rather than just a domestic issue. A Brexit could lead to a “protracted period of heightened uncertainty,” triggering financial-market volatility and hurting output, the Washington-based lender said in its annual assessment of the U.K. economy.