Investor universe expands around peripheral sovereigns

Fri Jan 10, 2014 11:13am EST

* Accounts lured by peripheral debt returns

* Rating agencies could provide further fillip

* Greece expected to return amid frantic demand

By John Geddie

LONDON, Jan 10 (IFR) - Frantic investor demand for peripheral European government debt is set to continue unabated in the weeks ahead, say market participants, after a series of new debt issues from some of the zone's most fragile economies were hoovered up this week.

Ireland, Portugal, and Spain all made impressive starts to their 2014 funding programmes this week, as investors looked to restock their inventories with peripheral debt products that have significantly outperformed equivalent core European paper over the last year.

"We have taken a bullish view on the periphery for the last few years, in contrast to many others. Now, it seems, this view is becoming consensual among investors," said Mark Dowding, co-head of investment grade at Bluebay Asset Management.

Spanish and Irish government bonds both made total returns of over 11% last year, while the German and French equivalents left investors with negative returns of minus 2.1% and minus 0.5%, respectively, according to research by Citi Bank.

"Investors can't afford to be underweight these markets, as their overall performance will suffer," said Philip Brown, head of SSA origination at Citi Bank.

This latent demand was evident when Ireland launched its first new debt sale on Tuesday after exiting its EU/IMF bailout last month, when more than 400 investors placed orders worth around EUR14bn for the 10-year bond issue.

Two days later, Portugal - which is still to be weaned off its official sector aid - received orders from 280 accounts amounting to more than EUR11bn for its five-year bond tap.

Yields on 10-year Irish debt have rallied nearly 20bp since the start of the year to hit lows of 3.28% on Tuesday, while the Portuguese equivalents have rallied over 80bp over the same period, hitting lows of 5.46% on Wednesday.

Investors remain confident this impressive rally is here to stay.

"The peripheral trade definitely has further to run, you just have to look at where it is trading versus corporate credit or emerging market sovereigns for evidence of that," said Dowding at Bluebay.

By comparison, French food retailer Casino, which is clinging on to its investment grade rating, has a 10-year bond bid at 3.16%, according to Tradeweb, while Russia, Baa1/BBB/BBB, has a seven-year euro deal which hit tights of 3% this week.

RATINGS FILLIP

The number of investors now focused on peripheral European paper is undoubtedly growing, and if rating agencies take a more positive view on these countries in the coming weeks, the trend could accelerate, say strategists.

Moody's announces its decision on Portugal's credit standing later on Friday, while S&P will offer its verdict on the country next Friday. While many market participants say an upgrade of Portugal's junk status is unlikely, they expected both Moody's and S&P to raise their outlooks.

The big mover, however, will be Moody's verdict on Ireland next week, especially as it is the only one of the three main agencies still to rate Ireland sub-investment grade.

"We're pretty much on the cusp of an upgrade for Ireland," said Matthew Cairns, a senior credit strategist at French investment firm AXA.

"Once Moody's lifts Ireland back to investment grade, there is potentially a flood of investors that have been restricted in investing in Ireland because of its junk rating."

SPREAD COMPRESSION

Any increase in the number of investors competing to buy the debt of these countries will only serve to reduce their borrowing costs relative to core countries.

The spread between Spanish and German 10-year borrowing costs was as wide as 465bp in the middle of 2012 as the market began to fear Spain would be the latest country to require a bailout.

Following solid demand for Spain's auctions of a new five-year bond and tap of a 15-year note on Wednesday, that spread fell to 174bp, and Bluebay's Dowding expects it to hit 150bp over the course of the coming quarter, heading back to levels not seen since 2010.

Market sources say Spain is planning to capitalise on demand for its paper by issuing a new 10-year bond via syndication, possibly as early as next week.

Rampant demand has led many market participants to speculate that even Greece may be able to fulfil its ambition to return to markets in 2014, just two years after it forced investors to take a haircut on their holdings as part of a restructuring.

"It would be good for Greece to have a shorter dated bond, so if international investors want to dip their toes back into Greece there is something shorter than 10-years," said Brown at Citi.

Yields on 10-year Greek bonds hit 7.60% on Wednesday, levels not seen since just after its first bailout in May 2010.

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