Cypriot bonds are the eurozone’s quiet star performers

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Amid “Trumpflation” trades and nerves over eurozone political risk, one corner of Europe’s debt markets has been quietly motoring along: Cyprus.

Having undergone a €10bn banking rescue at the hand of creditors in the EU and International Monetary Fund in 2013, Cyprus exited its bailout programme last year and has seen its government borrowing costs tumble to 15 year lows.

The yield on the country’s comeback 10-year bond issued in late 2015 has fallen to as low as 3.2 per cent from a peak of just over 4 per cent at the start of last year (see chart below). Its long-term borrowing costs are now at the lowest since at least 2001, according to data from the European Central Bank.

Investors are now demanding a higher premium to hold Portuguese bonds – also a former eurozone bailout nation – over the equivalent Cypriot assets.

That’s despite Portugal being included in the ECB’s stimulus programme, where the central bank has bought €26bn of Portuguese bonds over the last two years, helping keep a lid on its borrowing costs.

Cyprus has been excluded from the ECB’s QE programme since it exited its rescue programme in March 2016. The ECB holds just €248m of Nicosia’s government bonds on its balance sheet and decided to remove the waiver that allowed it to buy up the low-rated debt when the bailout a year ago.

Despite its small bond market of only €20bn, the country’s 10-year debt still offers a juicy yield to investors in a world where benchmark German Bunds are yielding 0.2 per cent.

Investors who bought Cyprus’s debut 10-year debt in October 2015 will have made over a 12 per cent return (including coupons). That compares to just a 2 per cent return on broader eurozone 10-year debt, according to data from Bloomberg.

Cyprus’s economy also has a lower overall debt to GDP pile than some of its Mediterranean counterparts at 110 per cent against 130 per cent in Italy and Rome. The island economy is expected to grow by 2.6 per cent this year, according to a consensus collected by FocusEconomics.

Last month, rating agency S&P hiked its rating on Cypriot debt to BB+ from BB with a stable outlook, citing the economy’s “gradual recovery” from its banking bust. The rating is still a notch below investment grade status, but is the same as Portugal.

S&P added it could deliver another upgrade to Cyprus in the coming year if authorities made further progress on reducing the banking system’s pile of bad loans.

“Financial markets have recognised [the economy's] positive developments”, Klaus Regling, head of the eurozone’s bailout fund said on Friday.

“The yields on public Cypriot debt have been coming down more than in other countries. The spread with Germany has narrowed more than for any other country in the recent months.”

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