By Derek Hynes
Since the markets re-opened for the New Year we have seen a flurry of peripheral new bond issues, namely 66 up until close of business on 15 February. In general new issue performance this year is good, with peripheral deals accounting for 42% of the supply by size. Of the peripheral supply, banks have dominated, accounting for 75% of total issuance year to date. This peripheral financial supply is biased to shorter-dated tenors (two to five-year maturity) with only eight non-financial deals which were predominately long dated by contrast (eight to 15-year bucket).
Up until mid-February, peripheral financials have enjoyed the strongest performance in primary both in terms of magnitude of spread tightening and by number with 70% of peripheral financial deals still tighter to re-offer spreads. For non-financial peripherals the story is more mixed with only half tighter to re- offer.
As long as the ‘Great Compression’ continues we expect the pace of supply from peripheral entities to increase. It is interesting to note that the last peripheral deal was on 25 January. Core European primary deals have continued since, albeit at a slower pace going into an earnings blackout period. It is not a coincidence that since then the Spanish 10-year government bond yield widened from its year to date low of 4.9% on 11 January to as high as 5.4% on 11 February. This week we saw the Italian 10-year government bond breach 4.8% following an inconclusive election result, a level it last traded at in November 2012.
Ultimately, access to public debt markets for peripheral entities at tighter spreads is positive for the recovery. This is the ECB’s primary goal in normalising the monetary transmission mechanism in Europe, making credit widely available to all and reducing Target 2 imbalances as a result. Germany’s Target 2 balance fell further in January to €616bn from a peak of €750bn in September 2012.
At Draghi’s press conference on 10 January he spoke of many risks to this ‘positive contagion’. Firstly the Spanish downgrades may continue from near junk to junk status after the attachment of a “negative outlook” to the ratings. Spain may also fail to request OMT aid prior to the German election window; this could leave Spain in a limbo period post summer until after the German elections where a failed debt auction could cause serious market disruption. The ECB may fail to live up to its conditional pledge (ESM sets the conditions to aid) to purchase an unlimited amount of Spanish or Italian debt (out to three years maturity) when the OMT programme is actioned.
Further down the line what if ESM conditions are breached or targets are not met? Will the ECB stop OMT purchases just when they are needed? Another worry lies in the question, what if growth continues to trend down and the recession in periphery deepens with growing electoral and political resistance to more austerity? Core European growth may also fail to recover and stronger countries may refuse to change their hardline stance on austerity and support the weaker ones.
Political efforts to reform the institutional set-up of the eurozone may wane under less market pressure, leaving the region still exposed to another escalation in the crisis further down the line. Regional politics will have a role to play in 2013 in Spain. We have German elections in September. Italian elections earlier this week failed to produce a favourable outcome which did surprise the market.
Derek Hynes is lead portfolio manager at ECM
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