For years after the 2010-2012 euro zone debt crisis, Italy, Spain and Portugal – collectively referred to as the “periphery” by bond investors – saw their bonds track each other. Anything that risked a repeat of the euro zone’s existential angst six years ago tarred all the weaker credits with the same brush. Yet six years after ECB chief Mario Draghi pledged to do “whatever it takes” to save the euro zone, the correlation is fading.
An uproar over Italy’s budget deficit and risks of a clash between Rome and European Union authorities have barely touched Portuguese and Spanish debt. Such has been the divergence that the premium demanded by investors to hold Italian risk over Spain’s hit its widest in over 20 years. “We are very close to record low levels in terms of correlation between peripheral countries, and it’s very clear that from the market perspective for the first time in a while a major euro zone bond market incident is not being seen as a threat to the euro system,” said Frederik Ducrozet, a global strategist at Pictet Wealth Management.
One reason is that the budget concerns are so far confined to Italy. But idiosyncratic risks have in the past spread across southern European bond markets too — one example being the approach to the Catalan independence referendum last year. Confidence is higher this time that the Italian debt problem will not threaten the country’s euro membership. The country’s anti-establishment coalition government has been at pains to stress it has no interest in exiting the zone.
Contagion would return only if the euro’s future is in danger, said Arnaud-Guilhem Lamy, a portfolio manager at BNP Paribas (PA:BNPP) Asset Management. Iain Stealey, a fixed income portfolio manager at JPMorgan (NYSE:JPM) Asset Management, said the fund he oversees has been buying Spanish government debt through the recent Italian ruckus.
“If you’re a fund manager and you don’t want to own Italy, Spain and Portugal are the only realistic alternatives,” he told Reuters. “Spain has been the poster child for European growth in recent years – if you think about 2012, where unemployment rates were, how strong concerns were over the banking system in the periphery, we are in a very different place now,” he said.
Spain has led the euro zone economic recovery in 2016 and 2017, growing more than 3 percent a year and earning multiple credit ratings upgrades to Baa1 from Moody’s and A- from both S&P Global and Fitch. Portugal, not long ago rated junk by all three major agencies, last week was restored to full investment-grade status after a Moody’s upgrade. Its economy grew 2.7 percent in 2017, outperforming the euro zone.
Both countries have benefited from their share of the ECB’s 2.6 trillion-euro ($3 trillion) stimulus program. But even countries partly or fully outside the ECB program have felt its effect. Cyprus recorded stellar growth of 3.9 percent last year and Greece exited its bailout program in August.
This week, Greece said it achieved a primary budget surplus well above target for the year so far. “The type of investors invested in Spain and Portugal is not the same as it was before,” said BBVA (MC:BBVA) rates trading strategist Jaime Costero Denche. “We have seen new investors such as Scandinavian accounts and Middle East and Asian investors who didn’t want to buy peripheral debt in the past.” A major factor limiting contagion from Italy is that Portuguese and Spanish banks are in better shape, thanks to authorities’ success in tackling bad loans — a road Italy embarked on only recently.
Portuguese banks have mostly returned to profit. In June, Moody’s lifted its outlook for Spain’s banking system to positive. It cited robust economic growth and improved asset quality after disposals of troubled assets.
Categories: Economic Indicators