Robeco: Peripheral Europe Update, week 37

Main market events

Developments in the US-China trade war and in Hong Kong, and a further pushback from ECB hawks against expecting too much fresh stimulus next week, prompted a sharp rise in longer-term bond yields. BTPs were the outperformers in the EGB market once again. Italian bonds have returned 13.5% year-to-date, Spanish bonds 10.3%, Portuguese bonds 10% and Irish bonds 8%.

Italy

Prime Minister Conte got the green light to form a new government after 5SM members largely voted in favour of the 5SM-PD coalition. Snap elections are now avoided. This reflected positively on the 10-year BTP-Bund spread which declined another 20 basis point to circa 1.50%, the tightest level since May 2018. Moreover BTPs up to 3 years again trade at negative yields now. Lower borrowing costs should help to ease Italy’s budget constraints and – if sustained – possibly end the negative snowball effect, i.e. when the average borrowing cost exceeds nominal GDP growth. Tonight Moody’s will update Italy’s rating, currently at Baa3 with a stable outlook. Expectations are for the rating to remain unchanged as latest political developments have alleviated concerns for potential downward pressure. Moody’s will however closely follow decisions of the new government, especially regarding the 2020 budget and the ability to implement policies to support Italy’s low growth.

ECB

Notwithstanding recent pushback from ECB officials, it’s still our expectation that President Draghi will announce a comprehensive policy package next Thursday. Staff projections for economic growth and inflation will likely be revised downwards once again. In our view, there should be enough arguments to cut rates by 10 to 20 basis points, announce a tiering system to mitigate adverse effects of negative rates on bank profitability and possibly sweeten the terms on the new TLTROs. We also believe it’s still much more likely than not that the ECB will announce a restart of net QE purchases. To ease concerns of the more hawkish GC members, the self-imposed issuer limit of 33% for government bond purchases could remain unchanged. That said, Mr. Draghi has an almost impeccable track record on delivering policy accommodation and we do not expect to change this at his penultimate press conferences as President.

Robeco Euro Government Bonds 

Over the past weeks we added to Italy exposure, reflecting our view that a 5SM-PD government coalition would be constructive for BTPs. Although the BTP-Bund spread tightened to its lowest level in over a year, we continue to believe that there could be more performance in store. Rating uncertainties are expected to fade, fiscal tensions to ease and further investor demand could therefore emerge. Also as the hunt for yield is likely to continue in the current global low – negative yield environment. The fund is 49% invested in peripheral bonds, which is 8% above the level of the index. Year to date the absolute return of the fund is 9.91%*.

_{* Robeco Euro Government Bonds, gross of fees, based on Net Asset Value, 6 September, 2019. The value of your investments may fluctuate. Past results are no guarantee of future performance.}