Back by popular demand
Talk about a shift in sentiment. Investors who were running the other way when eurozone borrowers wanted to do deals just a few years ago now can’t get enough of the stuff.
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As recently as 2012, sovereigns in the eurozone’s periphery would have struggled to give their debt away to global investors keener on emerging-market yield and growth. But in recent times, the tone and the tune have changed. With US and Asian buyers ploughing into Europe again in a big way, Depeche Mode’s “Just Can’t Get Enough” could be the song on many investors’ lips.
“Investors a few years back put Europe in the ‘too hard’ basket. Now, many investors are effectively saying: ‘I don’t have enough Europe. Get me some more’,” said Daniel McCormack, head of European and UK economics at Macquarie.
It is quite a turnaround, said Cagdas Aksu, director, fixed income strategy at Barclays: “Some of the investors who just a few years ago were looking to get out of peripheral eurozone countries are now looking for ways to get back in.”
European leaders are certainly welcoming once-absent investors with open arms. A prime example of the periphery’s new-found hunger for capital – and its ability to sell debt with ease – is Spain. In January 2014, the Kingdom priced a €10bn 10-year offering on more than €40bn of orders, the largest ever book for any European government debt sale.
Portugal is also eyeing a return to bond auctions after drawing a line under its three-year bailout programme, scheduled for June. Even Greece, not so long ago an investor pariah on a par with Argentina or Cuba, on April 9 priced a €3bn five-year issue, its first international bond sale in four years, dragging in €20bn in orders, and proving, said Morven Jones, EMEA head of DCM at Nomura, that the “overall landscape for eurozone funding is better than it has been since the start of the financial crisis”.
Curiously, much of the interest in freshly-minted peripheral debt comes “not from European investors, but from US then Asian investors”, said Zeina Bignier, head of DCM public sector origination at Societe Generale.
That’s another remarkable volte-face: two years ago, investors from those regions wouldn’t touch large parts of the eurozone with a 12-foot pole, leaving outlying states to fund themselves.
“If you look at the geographic distribution of syndicated issuance by peripheral eurozone states over the past three to four months, you see a marked shift from captive investor, domestic bases toward foreign investors,” said one London-based DCM syndication banker.
Yet no single factor is driving the revival of the region’s reputation among global investors, and the ability of even the most troubled sovereign to meet its funding needs.
Growth and yield are as ever uppermost on investors’ wish-lists – and at present the eurozone’s outer edges offer both. On April 8, Portugal’s 10-year bonds yielded 3.9%, a four-year low, against 3.21% for Spain’s and 3.24% for Italy’s. “Investor demand for yield and confidence in the recovery story is driving the outperformance of Spanish, Italian, Portuguese and Greek bonds,” said Jones.
The International Monetary Fund sees the eurozone’s economy expanding by 1% in 2014 and by 1.5% in 2015, and tips growth to emanate from all corners of the region, rather than just Germany.
In January, the fund predicted the economies of Spain and Italy to grow by 0.6% this year, and by 0.8% and 1.1% respectively in 2015, driven, said Antonio Garcia Pascual, chief eurozone economist at Barclays, by a “gradual improvement” in finances, and by higher internal demand.
The eurozone has also benefited from two interlinked factors outside its control: the US Federal Reserve’s tapering of its quantitative easing programme and a rush by some institutional investors from emerging markets to perceived safe havens, including, for now, higher-yielding debt issued by peripheral eurozone states.
It isn’t easy definitively to prove a direct link between emerging market outflows and eurozone inflows, but the evidence appears to support that theory. In the first three months of 2014, according to information provider EPFR Global, US$1.2bn in net additional capital made its way into funds invested in the debt of the five leading peripheral states. Over the same period, just shy of US$12bn fled emerging market bond funds.
“We see tangible flows out of emerging markets and into sovereign and corporate eurozone debt,” said Mariano Goldfischer, head of global debt markets at Credit Agricole.
Other factors have also worked to the eurozone’s advantage. Pierre Blandin, head of SSA DCM at Credit Agricole, said outflows of capital from emerging markets were “at least partly driven by tapering in the US”, which has led to investors broadly fleeing emerging markets and repatriating capital to developed markets in anticipation of higher interest rates.
Emerging market wobbles – slowing Chinese growth, Russia’s tussle over Crimea, political turbulence in Thailand and Turkey – have also helped.
Then there are the lingering effects of European Central Bank president Mario Draghi’s July 2012 vow to do “whatever it takes” to preserve the single currency.
“The bulk of improvements in the eurozone’s funding situation is due to ECB actions” in general, and Draghi’s pledge in particular, said Macquarie’s McCormack.
Not all good
But for every positive dynamic at work, there’s an equally powerful negative factor threatening to undermine the periphery’s newly re-found ability to finance itself at attractive rates. Three in particular stand out.
First, rising interest rates outside the eurozone. Most analysts expect the Fed to tighten monetary policy going into 2015, with the Bank of England likely to follow suit. As of April 8, yields on US bonds maturing a decade hence yielded 2.7%, a rate that continues to crank higher, closing in on peripheral European yields.
As that happens, investors are likely to turn their yield-hungry eyes to that safest of havens, the US, excising one of the periphery’s current binary selling points.
“Euro-area markets may be in for a bumpier ride” once the Fed hikes rates, said Rainer Guntermann, interest rate strategist at Commerzbank, who tips the Fed to tighten policy from mid-2015.
That may complicate the periphery’s ability to self-fund.
Said Nomura’s Jones: “One challenge for government bond issuers in general is ensuring that their issuance programmes can navigate the prospect of rising interest rates.”
Of even greater concern, at least to the region’s long-term growth outlook, is the spectre of deflation. Eurozone inflation has been becalmed in what the ECB refers to as its “danger zone” – below 1% – since October, and in March 2014, prices rose by just 0.5% year-on-year, the slowest rate of increase since 2010. ECB vice-president Vitor Constancio admitted on April 1 that low inflation was “of concern”, given the debilitating effect it could exert on the region’s tentative recovery.
Barclays’ Garcia Pascual said inflation would “remain very weak” both in the short-run and long-run, tipping it to remain below 1% in 2014, with long-term inflation also trending below 2%. Jolted into action over the issue, the ECB in early April opened the door to quantitative easing, while stopping short of rolling out a US-style programme of asset purchases to boost production and underpin prices.
That may change, said Pascual, if “inflation drops further and long-term inflation expectations worsen. We think the ECB is behind the curve on inflation.”
Not everyone is in alignment on that view – Macquarie’s McCormack said that worries over impending deflation were “overdone” – though the banking community expects QE to become a reality as the second quarter rolls on.
“Some form of QE can’t be completely ruled out now or in the weeks or months ahead. What form it may take is uncertain, but everything, from some form of sterilisation, to incentivising lending across the eurozone, is on the table,” said McCormack.
Perhaps the main threat from deflation is not inaction, but an inability to stop the rot. “Investors will start fretting if deflationary risks fully materialise and the ECB either doesn’t act, or does act, but it doesn’t work,” said Barclays’ Aksu.
Then there’s the final elephant in the room: debt. Across the periphery, debt-to-GDP ratios remain alarmingly high, at 124% in Portugal, 135% in Italy, and 157% in Greece.
Yet, said Philip Brown, head of sovereign capital at Citigroup, debt ratios are “not something which investors in the euro periphery are focusing on in the near-term. When interest rates [rise] … investors will focus on the budgetary challenges of rising debt service costs. At that point debt sustainability analysis will be a bigger issue than it is today.”
The last 18 months have been kind to the eurozone, particularly its battered periphery, but it isn’t Depeche Mode that the region’s borrowers should be humming. For now, bearing in mind that the eurozone’s recovery might prove to be little more than a dead-cat bounce, Simply Red’s “Money’s Too Tight (to Mention)” might be more appropriate.