Irish debt catching up to euro zone mainstream

LONDON Thu Jan 16, 2014 9:10am EST

LONDON Jan 16 (Reuters/IFR) - From bailout and near bankruptcy, Ireland has staged such a remarkable turnaround that its debt is now on a solid path towards France and Belgium - catching up with countries seen as safe bets when it was shunned by the market three years ago.

After a storming return to bond markets last week - meeting almost half its funding target for 2014 - Ireland is now eyeing an upgrade by Moody's, possibly as soon as Friday, that would unleash a further wave of investment.

Last week's 10-year debt sale offered a yield of just 3.5 percent, a far cry from the 15 percent quoted on secondary markets in mid-2011 and puts Ireland almost within 100 basis points of countries like France and Belgium, and a further 70 points away from benchmark Germany.

France and Belgium are sometimes described as members of the euro zone's "soft core", a tier of debt below core states like Germany but safer than the periphery countries hit hardest by the crisis, like Ireland, Portugal, Italy, Spain and Greece.

Dublin is hoping a run of good news - becoming the first euro zone country to exit a bailout, accelerating economic growth and falling unemployment - will continue on Friday when Moody's is due to review its "junk" rating.

If Moody's restores the country to investment grade, large, mainly Asian-based ratings-sensitive funds would be free to rejoin the scramble for Irish paper. Fellow ratings agencies Standards and Poor's and Fitch kept Ireland's investment grade rating during the crisis.

"Ireland's positive trajectory should continue, and the potential for it to trade flat to France or Belgium is very real, but it will still take time - it won't happen overnight," said Dan Shane, head of sovereign, supranational and agency (SSA) syndicate at Morgan Stanley.

"We would expect to see a number of accounts reopen lines for Ireland when Moody's upgrades the country to investment grade and they will need to buy to avoid being underweight their performance benchmark."

Moody's cut Ireland's rating to Ba1, one notch below former financial market pariah Colombia, at the height of the euro zone crisis in July 2011, prohibiting some sovereign wealth funds and Asian central banks from touching Irish debt.

While Irish paper is already much sought after - investors bid nearly four times the 3.75 billion euros issued last week - debt chief John Corrigan has said there is a huge potential for a push on bond yields if Moody's upgrades it.

With such funds able to place orders in blocks of some 300 to 500 million euros at a time, their return would have a big impact at auctions set to resume at a modest pace this year when 500 million to one billion euros are likely to be offered.

Some ratings momentum would move Ireland further away from fellow peripheral countries like Spain and Italy whose 10-year debt currently trades 25 to 40 basis points higher.

"PATH TO AA"

But Ireland still has some way to go to complete the rebalancing of its economy, and Moody's may make Dublin wait.

The agency, which nudged up its outlook on Ireland's rating to stable from negative in September, said just last month that an upgrade would require continued compliance with fiscal targets and a strengthening in the pace of economic growth.

Given it also downgraded its rating of Irish banks in late December, analysts at Glas Securities and Cantor Fitzgerald say an upgrade is more likely later this year and that a move to a positive outlook may be the best case scenario for Friday.

Moody's may also take no action at all, similar to Portugal last week when traders had expected an update under regulations that came into force this year.

An upgrade is seen by investors as inevitable at some stage, though, with moves by S&P and Fitch also anticipated.

"(An upgrade from) Moody's will not be transformational, but will certainly accelerate the move," said Philip Brown, head of SSA origination at Citigroup. "Ireland should be on a path back to A, and even onto AA."

The pace of the rally will may also depend on how quickly speculative investors that bought Irish paper at the height of the crisis - like Franklin Templeton - look to realise profits.

"The clear view is that Ireland will go back and trade with France and Belgium; how quickly depends on profit taking from deep 'in-the-money' investors. Should Ireland move to the 'soft core', these investors may want to exit and if that can be done in a controlled way, why not."

Moody's, which has maintained Italy and Spain on investment grade, currently rates Belgium seven notches higher than Ireland at Aa3 while France is nine notches above at Aa1 after being stripped of its triple-A rating over a year ago.

Despite having a debt of 124 percent of GDP - higher than Belgium's near-100 percent and the 93 percent and rising in France - Ireland has kept investors sweet by consistently hitting fiscal targets. Its open, structurally-sound economy is seen as one of the best bets on global growth.

With economic activity starting to pick up steam and forecast to better most of the euro zone with growth of 2 percent this year, investors believe Ireland also has the fundamentals to back up a ratings-driven rally.

"The story is very solid, Ireland is in a very nimble position," said one market participant in Irish debt, who declined to be named as he is not authorised to speak to media.

"There are so many advantages to help a move towards Belgium and France - not least political stability, the low corporate tax rate and an unemployment rate that can fall very fast. If debt peaks at 125 percent and gets to below 100 percent, then you're in a very strong position."

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