Southern eurozone governments’ borrowing costs hit the highest level in almost two months yesterday compared with Germany, amid a broad sell-off ahead of Sunday’s European parliamentary election results.
The widening in “spreads” between Italian, Spanish and Portuguese 10-year bond yields and German equivalents highlighted nervousness about rising euro-scepticism across the continent. Yields move inversely with prices.
Eurozone government bond yields have tumbled this year on rising investor confidence in the stability of Europe’s monetary union – and expectations of bolder European Central Bank action to head off the threat of deflation.
However, the rally went sharply into reverse late last week after the publication of weak European economic growth data, and the losses have intensified on worries about European politics.
“People have started to realise that in almost every European Union country you have a party that questions EU mechanisms. The market is trying to price that in,” said Alessandro Tentori, head of rates strategy at Citigroup.
The sell-off also reflected positioning ahead of June’s ECB governing council meeting, which is likely to agree further cuts in official interest rates – but disappoint those who have bet on large-scale “quantitative easing”, or asset purchases.
Illustrating the turn in investor sentiment, yields on Irish 10-year bonds also rose on Monday, despite the country’s credit rating being upgraded two notches late on Friday by Moody’s.
Italian 10-year bond yields rose eight basis points on Monday to 3.15 per cent, compared with a low of 2.91 per cent last Wednesday. Their spread over German Bunds widened to 182 basis points, the highest since March 24.
Portuguese 10-year yields were up 12 basis points at 3.86 per cent, the highest since mid-April, with their spread over Bunds also the highest since late March.
The sell-off in Spanish markets has not been as severe. Analysts pointed out that Spain did not have as strong a eurosceptic movement as other eurozone countries. But compared with German Bunds, Spanish 10-year bonds have also given up the gains of the past two months.
A strong showing by eurosceptic parties on Sunday would raise worries about the eurozone’s long term stability. But the bond market sell-off may not be sustained, analysts argued.
“It could be just the fact that there is a ‘risk event’ upcoming – it is about prudent portfolio management rather than anxiety about the likelihood of any specific outcome,” said Laurence Mutkin, head of global rates strategy at BNP Paribas.
“If you are going to take profits ahead of the ECB meeting in June, why would you want to wait until after the European elections? But that doesn’t change our long term view that the ECB will eventually launch QE and that will drive spreads lower.”
Periphery bond markets have also seen a flood of new issuance recently, which has added to the downward pressure on prices. There were signs that at least some longer term investors had taken advantage of the sell-off, however.
“Since Thursday, the ‘real money’ accounts have been buyers and hedge funds have been sellers. That makes you slightly more confident – many powerful investors are seeing this as an opportunity to ‘buy the dip’,” said Anton Heese, co-head of European rates strategy at Morgan Stanley.
Nevertheless, the size of recent bond market moves might prove damaging. “If you are now thinking that volatility is going to be higher, you need a higher yield to make those bonds attractive,” said Mr Heese.