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Europe’s Riskiest Sovereign Bonds Defy Market Nerves to Rally

Anooja Debnath and James Hirai
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Europe’s Riskiest Sovereign Bonds Defy Market Nerves to Rally

(Bloomberg) -- Europe’s peripheral government bonds are eluding the rush of money out of riskier markets amid the spread of coronavirus.

Greek bond yields dropped to a record low Monday after a Fitch Ratings upgrade marked the latest step in the country’s recovery from a debt crisis, while Italy’s bonds also rallied as local election results damped political risk. The gains exceeded an advance in haven assets such as U.S. Treasuries, German bunds and the yen on deepening fears over the spread of the virus.

While Greek and Italian bonds were also the best performers in Europe last year as yield-starved investors sought their high returns, in bouts of wider market risk aversion the securities generally suffered. Following a series of ratings upgrades and relative political calm, the gains Monday show economies on the periphery of Europe may be losing their status as the region’s black sheep.

“Peripherals arguably offer some insulation from the elevated uncertainty,” strategists at Rabobank International, including Richard McGuire, wrote in a note Monday. If bund yields push further into negative territory, investors “will be forced into higher yielding markets.”

Greek 10-year yields fell 15 basis points to their lowest ever level of 1.155% after Fitch lifted the nation’s rating by one notch to BB with a positive outlook on Friday. That’s good timing for the country to raise debt at lower borrowing costs, with the government on Monday mandating banks for a new 15-year bond sale. Investor interest would signal confidence in Greece’s long-term debt sustainability because the notes mature in 2035, after a euro-area safety net expires.

Italy’s benchmark yields dropped as much as 20 basis points to a more than two-month low at 1.03%, while an index of the nation’s banking stocks was relatively shielded from the global sell-off with a drop of 1.2%. In contrast, the Stoxx Europe 600 Index fell 2.3% in its worst decline since October, as the death toll from the virus climbed.

The spread between Italian and German yields, a barometer of the country’s risk, narrowed to the lowest since November after Italy’s populist firebrand Matteo Salvini lost regional elections, boosting Prime Minister Giuseppe Conte’s fragile coalition. Candidates for a Democratic Party-led bloc swept up 51% of the vote against 44% for Salvini’s center-right, while support for fellow coalition member and anti-establishment party Five Star Movement fell to under 5%.

“We think there’s room for spreads to tighten a little bit between Italy and Germany,” said Anthony Crescenzi, a portfolio manager at Pacific Investment Management Co. “The European Central Bank is being very supportive of the overall euro-wide story,” he said on Bloomberg TV.

While every improvement in rating and stabilization in national politics is a source of relief for investors, diving head first into peripheral bonds might not be the best tactic just yet, said Alessandro Tentori, chief investment officer at AXA Investment Managers in Milan. He cautioned that a ratings decision can’t be the sole reason for investing in Greece.

“The story in Greece sounds very positive right now, in particular they are adding liquidity to the market and investors have produced a squeeze in yields also thanks to the negative rates environment,” he said. “However, this all came at a huge toll for the population, which is the bit that worries me the most when I look at Europe.”

(Updates prices, adds PIMCO comment in eighth paragraph.)

--With assistance from Alice Gledhill, Blaise Robinson, William Shaw and Sotiris Nikas.

To contact the reporters on this story: Anooja Debnath in London at adebnath@bloomberg.net;James Hirai in London at jhirai3@bloomberg.net

To contact the editors responsible for this story: Dana El Baltaji at delbaltaji@bloomberg.net, Neil Chatterjee, Paul Dobson

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