Peripheral bonds traded well last week as chances of a hard Brexit are fading, constructive noise around the US-China trade talks continue and Fitch kept Italy’s rating on hold at BBB negative.
04.03.2019 | 10:06 Uhr
Fitch kept Italy’s rating at BBB and the outlook was maintained at negative. This outcome served as a small relief for the market. Indeed Italian bonds rallied over the week, further supported by a constructive backdrop for risk. The spread with Germany tightened to 2.56% in 10 years. Whilst the spread has now made up most of the ground lost in February, it is still slightly higher than the level seen at the start of the year.
The European manufacturing slump extended into Spain. On Friday, Spanish manufacturing PMI fell 2.5 points to 49.9. The Italian PMI remained subdued, at 47.7 in February. Brexit and tariffs uncertainty are still weighing on manufacturing confidence in Europe.
The past months have brought a barrage of negative economic news out of the euro area and “technical recession” has become the new buzzword. In this environment even the hawks will find it difficult to argue for higher rates, as was illustrated by Dutch central bank president Klaas Knot recently arguing for a “wait and see” approach. We expect next week’s Governing Council meeting to bring lower growth forecasts and strong hints on new TLTROs. The official TLTRO announcement will probably follow in April, as details are still being discussed. The potential for surprises in new TLTROs and in changing forward guidance has diminished quite a bit after the pre-announcements by Benoit Coeuré and Peter Praet.
Friday before the Fitch rating announcement we reduced the underweight in Italy. Italy did lag the broader market considerably, making a bounce more likely than not. Given the current supportive backdrop for risk we also reduced the underweight in Spain by adding 5 year paper. More broadly however we continue to favor semi-core countries over the periphery for now. In France we are now flat relative to the benchmark whilst remaining an overweight in long dated bonds from Belgium. The fund’s investments in peripheral bonds amount to circa 35%, about 5% below the level of the index. Year to date the absolute return of the fund is 0.78%