Less than a decade ago, investors could barely be compensated enough to hold the bonds of Spain and Portugal for fear the nations could be severed from the European Union. Now, they are a hair’s breadth away from having to pay for the privilege.
An unprecedented surge in sovereign debt across the world has driven 10-year yields in the Iberian nations to record lows just shy of 0 per cent. With about $16 trillion (€14.4 trillion) of global debt now paying negative rates, investors are snapping up positive yields wherever they can find it – even if that means getting into some of the euro area’s riskier markets.
While that marks an extraordinary turnaround for countries once on the brink of bankruptcy, it also highlights a new era for bond markets where yields are perpetually low and central banks can do little to revive inflation. And it comes with its own perils -- the growing fear that a bond bubble is in the making.
“I am afraid all curves are going to zero and all rates are going to zero,” said James Athey, senior investment manager at Aberdeen Standard Investments, who currently has no positions in the debt of Spain or Portugal. “It would be an incredibly concerning signal.”
Yields have hit record lows across the euro area, and turned negative in the highest-rated markets, as pessimism deepened over global growth prospects. The rally is also being fueled by rising expectations of policy easing by the European Central Bank. The ECB should come up with an "impactful and significant" stimulus package at its next meeting in September, policy maker Olli Rehn was reported as saying on Thursday.
"In a regime of financial repression, this is normal," said Jorge Garayo, a fixed income strategist at Societe Generale, referring to the ultra-low yields. "The big question is how the whole thing unravels over time. Lower yields incentivise more borrowing when debt levels are already at high levels."
Ten-year yields fell below 0.1 per cent in both Spain and Portugal last week – a far cry from highs of almost 8 per cent and 18 per cent, respectively, seven years ago when the nations battled a debt crisis and had to accept financial rescue packages from either the European Union or the International Monetary Fund. For both countries, the yield spread over Germany, a key gauge of risk, touched a record low of 60 basis points last month.
While the Iberian nations’ debt ratings are still well below those of top-ranked nations such as Germany, they have recovered some levels from the post-crisis lows. Spain is currently rated Baa1, or three notches above junk, at Moody’s Investors Service, after being cut as low as Baa3 in 2012. Portugal is now at Baa3, the lowest investment grade, after sinking three levels into junk category earlier.
The two countries still have elevated levels of debt, an indicator of relatively high risk, with Spain’s liabilities totalling to 98 per cent of output and Portugal’s running at 126 per cent.
Economic rebound
Iberian bonds have also drawn strength from the region’s economic comeback. Despite patches of political uncertainty, such as the Catalonia crisis in 2017, the two nations have consistently posted some of the euro area’s highest growth rates. Portugal and Spain saw their economies expand 1.8 per cent and 2.3 per cent respectively in the year through June, compared to stagnation in Germany.
Additional support for Spanish and Portuguese bonds has come from the European Central Bank’s €2.6 trillion debt-buying program, which guaranteed a buyer even during times of turbulence. Portugal was kept in the program after DBRS was the only rating agency that refrained from downgrading it to junk even as the country had to depend on an IMF bailout plan in 2011 to weather the crisis.
“The Iberian countries have made great economic progress year after year,” said Ruediger Kerth, a portfolio manager at Union Investment in Frankfurt. “The outlook remains promising.” - Bloomberg
