Robeco: Improving trend in Italian and Spanish fiscal budgets

Main market events
Peripheral bonds performed relatively well over the past two weeks, with spreads tightening especially in Italy and Spain. Spreads were resilient amid the risk-off triggered by escalating tensions related to trade tariffs between the US and China and disappointing Eurozone PMIs. Spreads may have benefited from the ECB debates about the formulation of the forward guidance after the end of QE, with Draghi steering expectations towards a very “measured pace of rate hikes”. Today at the EU summit in Brussels, European leaders will discuss “more ambitious proposals in the fiscal and economic dimension” of the Monetary Union, in particular the completion of banking union and a common corporate tax base. Italian bonds have returned 2.65% year-to-date, Spanish bonds 3.26%, Portuguese bonds 2.54% and Irish bonds 0.4%.

Italy
Italian president Matarella concluded a first round of consultations with party leaders on support for any majority government. No support was found. That brings the process to the second round, in which party representatives will discuss the possibilities for a coalition among themselves. These talks will start next week. Chances of a Lega-Five Star coalition are rising somewhat, but in our opinion finding a coalition government may prove challenging and may well take several months.
Italian budget data for 2017 show a deficit of 2.3%, versus a target of 2.1%. However, excluding one-off payments for capital injections to the banking sector the deficit was circa 2.0%. Revenues increased by 1.5%, while expenditures excluding those related to the banking sector rose 0.6%.

Spain
As expected, Spain was upgraded from BBB+ to A- by S&P. “Strong economic performance, a solid current account and ongoing budgetary consolidation”, were the main arguments for the upgrade. S&P also raised the outlook to positive, suggesting further upgrades are possible. Recent data show the 2017 budget deficit was in line with the 3.1% target, 1pp below 2016 levels.
The Spanish government is planning for another voluntary early repayment of ESM loans in May. After this EUR 3bn repayment, Spain’s ESM debt will have declined from EUR 42bn to EUR 27bn.

ECB
Asset purchase data for January-March show that the ECB has not frontloaded any purchases yet. As the ECB reduces purchases in Summer, front loaded bond buying can be expected April-June.

Robeco Euro Government Bonds
We have modestly increased positioning in euro peripheral bonds. The fund is now overweight 5-10 year Italian bonds, 10-year Portuguese bonds and 10-year and longer-dated Spanish bonds. The fund still holds no Irish bonds as their spreads over France do not compensate for the potential risks stemming from Brexit and the volatility inherent to Ireland’s size. Currently the fund is 48% invested in peripheral bonds, well above index level. Year-to-date the fund’s absolute return is 1.53%*.

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_{* Robeco Euro Government Bonds, gross of fees, based on Net Asset Value, 5 April, 2018. The value of your investments may fluctuate. Past results are no guarantee of future performance.}