15.04.2019 10:59:02

Robeco: Peripheral Europe Update

Peripheral bonds rallied the past week, outperforming Bunds. Brexit concerns eased as the UK deadline for departing the EU was pushed out to October.

Another dovish ECB meeting also supported country spreads. What is more, stabilizing European growth data reinforced hopes that Europe can avoid a recession this year. This was reinforced by strong Chinese credit data, the Chinese business cycle has tended to lead the European one of late. Italian bonds have returned 2.4% year-to-date, Spanish bonds 3.6%, Portuguese bonds 4.3% and Irish bonds 3.1%.

Italy

The reduced volatility in the BTP - Bund spread and lack of willingness of the EC to seek a confrontation with Italy into the European elections seems to have enticed investors to set up fresh carry trades. However, for the Italian bond market to find more lasting support, the credibility of the government’s fiscal policy is still an important hurdle to take. Indeed, the latest projections of the budget deficit for the coming years and the government rhetoric on tax cuts and the planned VAT hike clearly show there’s a large risk of fiscal slippage.

Spain

A dovish ECB and the Brexit delay paved the way for Spain’s 10 year yield to decline below one percent for the first time since 2016. Favourable net supply dynamics this month also helped Spanish bonds. One would forget that elections are due later this month.

ECB

With market based measures of inflation expectations well below the ECB’s inflation target, the ECB’s credibility seems at stake. At Thursday’s ECB meeting president Draghi therefore kept the door to further policy easing - beyond extending forward guidance – wide open. Draghi stressed several times that “the governing Council stands ready to adjust all instruments, as appropriate". The ECB is aiming to avoid a scenario similar to 2011, when the ECB embarked on monetary tightening too soon. Before resorting to some sort of tiered deposit system, the ECB will likely first decide on the terms of the upcoming TLTRO3. They may not be much less generous than the TLTRO2s after all.

Robeco Euro Government Bonds 

Before the ECB meeting we trimmed back the Italy underweight, taking a more neutral stance. We expected a relatively dovish outcome which, at least for the short term, could provide support for the BTP-Bund spread. Positions in the periphery and semi-core are concentrated in longer-dated bonds. In this area spreads versus Germany look most attractive. The fund’s investments in peripheral bonds are at circa 33%, about 7% below the level of the index. Year to date the absolute return of the fund is 2.7%.*

* Robeco Euro Government Bonds, gross of fees, based on Net Asset Value, 12th April, 2019. The value of your investments may fluctuate. Past results are no guarantee of future performance.

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