Best Bonds in Euro Region Show Investors Don’t Miss a Government

In a world where political risk occupies investors more than ever, sometimes it’s better not to have a government.

Spanish bonds have returned 3.5 percent over the last three months, the best performance of anywhere in the euro region, according to Bloomberg World Bond Indexes. There’s been parliamentary gridlock since elections in December and June produced no clear winner, yet 10-year bond yields show the country pays the least to borrow compared with Italy since January 2015.

Spain continues to lure investors as the economy improves -- Acting Finance Minister Luis de Guindos told a local newspaper this week that growth in 2016 will exceed 3 percent -- and the European Central Bank pumps money into the market. The lack of a government may even be a draw for some investors because spending is kept in check, while the challenge from the anti-austerity Podemos party has faded.

“The paradox is that having no government is something that can even be good for your fiscal performance,” said Mark Dowding, a partner at London-based BlueBay Asset Management LLP, which oversees about $50 billion.

Neighboring Portugal is the opposite. It’s the only bond market in the euro region to lose money this year, singled out by investors because of political dawdling over budget cuts, the sustainability of its debt and the money it needs to pump into ailing banks.

Italy also looks a riskier alternative as it faces a referendum in the fourth quarter that may cost Prime Minister Matteo Renzi his job. Italians will vote on constitutional changes to curb the power of the Senate and Renzi has said he will step down should he lose.

“We’re in a low-yielding environment and the question investors ask is what are the least risky bonds and Spain seems to fit the bill, especially when you look at its immediate peers,” said Orlando Green, a rates strategist at Credit Agricole SA’s corporate- and investment-banking business in London.

Even so, there are signs in Spain that the economy might start to decelerate in the fourth quarter. The Public Works Ministry and state companies have said the value of contracts fell 20 percent in the first half of the year as the political paralysis dragged on. 

It makes it tougher for Spain to keep replicating recent returns, though the case for investors remains broadly intact, said Dowding.

Spain also repeatedly missed European Union targets to cut its budget deficit. Without a fixed government in place, Spain will only be able to roll over its 2016 spending program without the cuts officials in Brussels are demanding. De Guindos has said Spain is committed to narrowing its budget deficit to below 3 percent of gross domestic product -- the threshold for euro members -- by 2018.

“In terms of them not spending because there’s no government, that could be a positive in the short term,” said Green. “It will require policy action to finally abide by the EU budgetary rules.”

— With assistance by Lukanyo Mnyanda