Robeco: Peripheral European Update

Main market events

Risk sentiment deteriorated sharply as the US-China trade war escalated, supporting safe-haven bond markets. The 10 year Bund yield reached a new all-time low at -0.21%. Meanwhile, a string of negative news sent BTPs tail spinning. Portugal and Spain defied the deterioration in risk sentiment. Yields on 10y SPGBs declined to 0.73%, also a new record low. Italian bonds have returned 1.7% year-to-date, Spanish bonds 5.4%, Portuguese bonds 6% and Irish bonds 3.8%.

Italy

News reports that the EU commission may open a disciplinary process against Italy for not complying to it’s fiscal rules, rhetoric from deputy-PM Salvini about the need for more fiscal stimulus, and chatter about a parliamentary motion asking the government to use “mini- T-bills” to pay debt in arrears all added to the suspense around BTPs. The 10y BTP-Bund spread widened by more than 25bp to above 290bp, more than reversing last week’s tightening. Moreover the 2-30Y spread bear-flattened over 25bp. The 10y BTP-SPGB spread reached 200bp and, quite astonishing, 5y Greek bonds (B+) now trade through 5y BTPs (BBB rating). Although idiosyncratic risks around BTPs are significant, the lack of contagion so far to other EGB markets is remarkable. However, current spread levels versus other peripherals should provide some support for BTPs. 

Spain

Next week both the Spanish manufacturing and composite PMIs will be released. The aggregate Eurozone PMIs published earlier this month indicated some weakness in the periphery, and thus also possibly in Spain. Given Spain’s strong performance over the past weeks – the 10y SPGB-Bund spread tightened more than 10bp to 94bp – a negative surprise could result in a pullback of SPGBs versus other markets.

ECB

Market expectations around next week’s ECB meeting are muted. We are more hopeful and believe the ECB could deliver a dovish surprise. Besides setting favourable terms for the new round of cheap bank financing – i.e. offering loans at negative rates – the ECB could extend forward guidance into next year, and/or suggest that restarting QE is an option in case inflation expectations in the Eurozone weaken even further. 

Robeco Euro Government Bonds 

The underweight in BTPs was reduced, locking in a profit. The 10-30y BTP flattener position, expressing a cautious bias, remained in place. Also the fund kept its underweight in Portugal and Spain, as valuations are stretched, especially versus Italy. Given the recent underperformance of Ireland we closed a small underweight. Investments in peripheral bonds increased slightly to 30%, still about 10% below the level of the index. 
Year to date the absolute return of the fund is 3.32%*.

* Robeco Euro Government Bonds, gross of fees, based on Net Asset Value, 31