Investors could be forgiven for thinking the eurozone crisis is over. Earlier this month, Greece returned to the international capital markets after a four-year hiatus. Its five-year bond auction, which was more than eight times oversubscribed, raised €3 billion (£2.46 billion) paying 4.75% interest. This compared to a 6.1% interest rate on its last equivalent debt sale carried, back in 2010.
Aided by this – and the Federal Reserve’s latest minutes, which reduced expectations of an imminent US rate rise – the entire European periphery has seen spreads tighten further.
Yields on Spanish 10-year debt recently fell to 3.2% (the lowest level since 2006), while equivalent Italian paper hit a 14-year low of 3.15% last week, after peaking at 7.15% in December 2011. Portuguese 10-year paper has delivered investors a 45% gain over the past year with yields now at 3.65%.
Adding to the sense of complacency in the markets, the Bank of Ireland last month issued €750 million of five-year mortgage-backed covered bonds with a 1.75% coupon.
For James Tomlins, manager of the M&G European High Yield Bond fund, there are signs that investors are no longer pricing in a risk premium for the periphery. Pointing to the Irish covered bond issuance, he said: ‘These bonds now trade above par, with a yield to maturity of 1.5%. The market is not pricing in any material risk premium relating to the Irish housing market.’
But some still back the periphery. GaveKal economist Nick Andrews recommends staying long Portuguese assets, saying although 10-year yields have fallen to 3.65%, they still offer a 220 basis point premium over bunds and 60bps above Spanish bonos.
He said this fails to reflect the fact Portugal has exceeded the fiscal targets set by the Troika, reducing its budget deficit a full percentage point higher than mandated while generating a current account surplus for the first time since 1968.
‘Investors continue to benefit from one of the eurozone’s highest yielding bond markets in what is a growing economy with low inflation and a reasonable reform trajectory,’ Andrews said. ‘Given the spread over markets such as Spain, Italy and Germany, Portugal would seem to still offer value.’
BlackRock’s head of European & Global bonds Scott Thiel agrees, saying: ‘Portugal and Slovenia are now among our highest conviction views and although we have already seen significant spread compression, particularly in front end Portuguese government bonds, we expect a further decline in their respective spreads over bund yields.’
Despite the positives around the periphery’s restructuring, current yields seem to offer little wiggle-room if there were an unexpected macro shock, however.