Greek, Portuguese Bonds Lead Resurgence of Europe's Periphery

  • Greek 10-year yields are approaching levels seen before 2009
  • Analysts expect spreads to tighten more versus core euro bonds

Greek and Portuguese bonds are leading a revival of demand for peripheral European debt as investors turn sanguine on euro-zone risks and volatility stays low.

Yields on Greek 10-year securities are heading toward levels last seen before the credit crisis in 2009, while investor returns on Portuguese debt are second only to Greece in the last three months, according to Bloomberg World Bond Indexes. Irish bonds also rank in the top 10, marking a turnaround for Europe’s laggards as risk flees the market after anti-euro candidates failed to win in the Dutch and French elections.

“Peripherals still have room to outperform,” Ciaran O’Hagan, head of European rates strategy at Societe Generale SA, said in emailed comments. “The prospect of more low volatility is great for holders of credit risk.”

By comparison Switzerland and Germany have Europe’s worst-performing bonds, with the need to hold haven debt as a hedge against a victory for anti-euro Marine Le Pen having dissipated. German debt has also been the biggest beneficiary of the European Central Bank’s bond-buying program, whereas the likes of Portugal and Ireland are less vulnerable to any talk of tapering as they’re only the eighth and 10th biggest recipients from quantitative easing.

“We think that core European bond yields are unlikely to rise much further from here and if so, then peripheral spreads should tighten as carry trades get put on,” said Peter Chatwell, head of European rates strategy at Mizuho International Plc in London. “We would expect that if rates-market volatility remains close to historical lows, then more investors will look to increase their allocation to peripherals.”

The normalized implied volatility for options expiring in three months on 10-year euro interest-rate swaps has fallen to its the lowest since October.

Chasing Yield

Greece is the star peripheral performer, with its 10-year yield premium over Germany having fallen over 200 basis points in the past three months to hover at the lowest level since 2014. At a recent Greek auction, 13-week bills saw a bid-to-cover ratio of 1.61, the strongest since Alexis Tsipras was elected to office in early 2015. His government this month ended its latest impasse with international creditors over the terms of a bailout program.

Euro-area finance ministers will next meet on Monday, where the issue of its debt relief has a 50 percent chance of a deal, according to an EU official. The balance of risks points to further upside for Greek debt in the next few months, with gradual economic improvements and the potential for inclusion of its bonds in the ECB program, according to Pavilion Global Markets Ltd.

Commerzbank AG remains wary of being too optimistic on Greece and prefers Portugal, where “a similar and even more impressive performance is taking place,” said Christoph Rieger, its head of fixed-rate strategy. Portuguese yields fell as much as 10 basis points on Wednesday, with the spread over bunds having fallen around 100 basis points since March.

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In the same period, Irish and Spanish 10-year yields both tightened around 30 basis points versus bunds. Ireland’s economy and public finances have been continuously improving, which will likely extend the trend over the coming years, according to Moody’s Investors Service, while Spain’s economy shows signs of renewed momentum.

Italian bonds have lagged other peripheries, weighed down by the prospect of the anti-establishment Five Star Movement coming out on top in elections early next year. That hasn’t stopped Franklin Templeton Investments loading up on the nation’s bonds, while Societe Generale’s O’Hagan pointed out the Italian vote is still nine months off.

“Investors are chasing yield as the event calendar looks far less threatening,” he said.

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