Europe’s Worst Bonds Defy Market Rout to Have World’s Best Month

  • Portuguse debt finally makes some money for investors
  • Country keeps credit rating but has anything really changed?

Europe’s worst-performing bonds are attempting to defy gravity.

Portugal has been the laggard of 2016, but its sovereign debt returned investors more than anywhere else in the developed world this month, according Bloomberg bond indexes. Albeit meager, the 0.2 percent gain stands out because it came as markets elsewhere tumbled, with German benchmark securities losing 2.1 percent and headed for their worst month since June 2012.

While political risks remain as Portugal tries to reduce borrowing and get a grip on its budget, concern the country would lose its only investment grade rating has dissipated after DBRS Ltd. kept it unchanged. Investors are more confident in a market that has been a proxy for the lingering effects of the European debt crisis, its bonds getting hammered during a global rout at the start of the year despite having the European Central Bank’s asset-purchase program as a backstop.

“It’s a recovery after a very bad year,” said Ciaran O’Hagan, the head of European rates strategy at Societe Generale in Paris. “The worst that could happen next time round is a negative outlook, so there won’t be any downgrade for at least a year, and possibly longer. That’s very good news if you were to buy Portugal.”

Portugal’s bonds rallied after DBRS announced on Oct. 21 its decision to keep the nation’s credit rating at BBB, the lowest investment grade, though one that ensures the securities remain eligible for the ECB’s quantitative easing. The three main rating companies all consider Portuguese bonds as junk.

The premium on 10-year bonds compared with German benchmarks dropped to the lowest in a month on Thursday. While yields since have risen back up to 3.3 percent, that’s still almost 30 basis points lower than three weeks before. At an auction of five-year securities last Wednesday, Portugal’s borrowing costs declined, with bonds due in April 2021 being issued at a yield of 1.751 percent.

Yet it was also the month when the Portuguese government cut its growth outlook and said the budget deficit and the country’s debt ratio will be higher than previously forecast.

The economy will grow 1.2 percent in 2016, lower than an estimate in April. The deficit will be 2.4 percent in 2016, which is wider than the 2.2 percent target announced before, albeit still within the limit set by the European Commission. Debt is projected to increase to 129.7 percent of gross domestic product this year from 129 percent in 2015.

“The market assigned a high risk impact to the DBRS decision and this has abated for the time being,” said Kim Liu, a fixed-income strategist at ABN Amro Bank NV in Amsterdam. He expects Portuguese bonds to continue their recovery. “But the fundamentals and the relatively weak position of the government has not changed. Portugal is still facing the pressure of high debt, low growth and a vulnerable banking sector.”

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