Like farmers, financially strained eurozone governments make hay while the sun shines.
Encouraged by low market borrowing costs and strong investor demand, finance ministries are further ahead in funding programmes than at this stage in at least the past three years. France, Spain, Italy, Belgium and the Netherlands have raised more than half the year’s expected total, according to estimates by Barclays.
Even though the eurozone is in the deepest recession since the launch of the euro in 1999, the exceptional harvest suggests European Central Bank action to shore up the eurozone is bringing tangible benefits by lowering financing costs.
“Globally, central bank action is driving up asset prices. In the US we have seen it in house prices, which is helping the economy,” says Erik Nielsen, chief economist at UniCredit. “Here it is in sovereign debt – which will also help the economy but the effects will take longer.”
After the eurozone crisis erupted in early 2010, southern eurozone governments often struggled to raise long-term debt. The average maturity of both Italian and Spanish debt was 6.85 years in 2007. It has since fallen below 6.5 years in Italy and 6.4 years in Spain.
But last July, Mario Draghi, ECB president, pledged to prevent a eurozone break-up. He has also cut interest rates and flooded the financial system with liquidity. Meanwhile, bond-buying programmes by the US Federal Reserve and Bank of Japan have also encouraged investors hunting for better returns to look more favourably on Europe’s monetary union.
Italian 10-year bond yields, which move inversely with prices, last month dropped below 4 per cent for the first time in nearly three years. France saw 10-year yields tumbling this month to a record low of 1.7 per cent. Greece last week saw yields falling sharply after a credit rating upgrade by Fitch.
“There was a lot of real money on the sidelines which was put to work in April and May – as well as expectations of Japanese inflows,” says Laurent Fransolet, head of fixed-income research at Barclays. “Hedge funds have moved towards neutral but I suspect they are still on the short side – so are buying to cover positions. Investors are saying ‘the eurozone is turning, there is limited room for disappointment and it yields a decent amount’.”
Hedge funds have moved towards neutral but I suspect they are still on the short side – so are buying to cover positions
– Laurent Fransolet, Barclays
When Spain last week issued 10-year bonds, demand was three times greater than the €7bn raised. Italy raised €6bn from 30-year bonds, the first with such a long maturity since 2009. Earlier this month, Portugal issued €3bn of new 10-year bonds, its first since the country requested an international bailout programme two years ago.
Yields have risen as the market has absorbed the stronger supply and in line with US and Japanese bonds. But Europe’s rally goes broader than sovereign debt. The FTSE Eurofirst 300 index is up almost 8 per cent since the start of the year. US distressed debt hedge funds are scouring for opportunities. Big European companies are also seeing borrowing costs tumbling. European investment grade corporate bond yields have fallen to an all-time low of 1.75 per cent, from 2 per cent at the start of the year.
“It all makes for a virtuous circle – at least in the short term,” says Hans Lorenzen, credit analyst at Citigroup. “Sovereigns and corporations get ahead of their funding schedules. There are fewer worries about a looming wall of refinancing. Optimism rises.”
There is just one snag. There are scant signs of economic prospects improving. Eurozone gross domestic product contracted 0.2 per cent in the first quarter of 2013, and interest rates remain penal for southern European companies unable to tap capital markets.
“Where falling sovereign borrowing costs have an impact is on high-yield corporate bonds in the eurozone ‘core’ countries. But most companies in the periphery do not issue bonds,” says Gilles Moec, European economist at Deutsche Bank. “They are entirely dependent on bank lending. There is a wall between what happens to public sector bonds and funding for the private sector.”
Italy and Spain face hundreds of billions of issuance over multiple years. So you need to see it from the perspective of maintaining confidence over the long term
– Andrew Bosomworth, Pimco
The severe recession, weak banks and high unemployment across southern Europe, meanwhile, are increasing government funding pressures. “It is reassuring that they are getting along well with funding, and at the margin getting ahead of plans. But Italy and Spain face hundreds of billions of issuance over multiple years. So you need to see it from the perspective of maintaining confidence over the long-term,” says Andrew Bosomworth, European portfolio manager at Pimco.
One feature of recent issuance has been a reliance on syndicates of banks drumming up investor interest, rather than traditional auctions by debt agencies. “It is a sign of relative weakness because those who do not have any problem issuing don’t need a bunch of bankers to distribute the stuff – people come to them,” one large investor says.
And sunny market conditions, in which investor appetite for debt far outstrips supply, can change suddenly. In January 2010, Greece received €25bn in orders for €8bn of five-year securities. Just weeks later, the country plunged the eurozone into existential crisis.