Yields on the eurozone’s lower rated debt fell on Friday as the European Central Bank’s rate cuts and openness to a large scale bond buying programme pushed investors towards riskier assets in their quest to maximise returns.
An expected ceasefire between Ukraine government forces and pro-Moscow separatists prevented sharp yield falls in top-rated German Bunds, an asset of choice amid geopolitical concerns.
The ECB cut its main refinancing rate to 0.05%, raised the penalty for banks for keeping money overnight in central bank deposits to 0.20%, and announced a new programme of asset-backed securities and covered bond purchases.
ECB President Mario Draghi also left the door open to bond purchases with newly printed money, a tool known as quantitative easing, or QE, although questions remain over German resistance to such a step.
Yields negative in Northern Europe
Spanish and Italian 10-year yields fell 4 basis points to 2.13% and 2.33%, respectively, within touching distance of their record lows and just over one percentage point over German Bund yields.
“The main beneficiaries are the peripheral markets, and I still think there is scope for spreads to narrow over Bunds, particularly in Spain,” said Nick Stamenkovic, bond strategist at RIA Capital Markets.
“People are still searching for yield. While the ECB underpins the short-end of the curve, investors are going to look to extend duration.”
Two-year yields were negative in Germany, the Netherlands, Belgium, Austria, France and Finland – meaning investors are effectively paying those governments to hold their money. Ireland’s two-year yields were close to zero.
The highest yielding two-year bond in the eurozone was Portugal’s at 0.67%, down from over 22% at the height of the crisis in 2011.
End of ECB support to austerity?
In a landmark speech last month, the head of the European Central Bank said it would be “helpful for the overall stance of policy” if fiscal policy could play a greater role alongside the ECB’s monetary policy, adding “I believe there is scope for this”.
On Thursday, he expanded on the comments, stressing that while reform remained vital and the bloc’s debt rules were inviolable, carefully selected tax cuts and government spending in receptive parts of the economy would be beneficial, and could even be done in a “budget-neutral way”.
It marks an end to the tacit coalition of ECB support, in combination with German-style fiscal austerity, that has been in place since the outbreak of the eurozone crisis, and leaves Draghi positioned closer to France and Italy now than Berlin.
But the world’s top rating agencies are taking a cautious stance on Mario Draghi’s call for tax cuts and growth-friendly tinkering of fiscal policy in the eurozone, warning that France’s credit rating would be most at risk if it fails to noticeably improve growth.
For ratings firms, the worry is that a slackening in the euro zone’s austerity drive could see further delays in long-promised moves to cut debts and streamline their economies.
France and Italy are already angling for more time to comply with the European budget deficit rules, and France’s finance minister said this week that low inflation would probably mean it has to scale back next year’s budget savings plans.
The worries are putting France at the top of the rating firms’ watch list, though Italy is also a concern as its economy struggles for momentum.
S&P and Fitch both current have a ‘stable’ outlook on their respective AA and AA+ French ratings though Moody’s, with its AA+ equivalent Aa1 rating, already has it on a ‘negative’ outlook.
“French debt to GDP is expected to peak next year at 96-97 percent, and we have already indicated that that is very much at the higher end of the range for a country on AA+,” said James McCormack, Fitch’s global head of sovereign ratings.
“If spending didn’t turn out to be growth supportive and the debt dynamics deteriorated further, if it delayed the peaking of debt to GDP ratio and pushed it higher, that could be a concern.”
Hornung at Moody’s added: “Debt and debt to GDP metrics have been trending up in France for years, and fiscal consolidation targets have been revised on an ongoing basis. That is not positive for the credit.”
Euro zone inflation fell in July to its lowest since the depth of the financial crisis nearly five years ago, highlighting deflation risks on the European Central Bank's radar.
The ECB cut all its interest rates to 0.15% in June, an all-time low. It also promised up to €1 trillion in cheap long-term loans to banks from September, and kept the door open to a programme of large-scale asset purchases, known as quantitative easing (QE).
In August, French President François Hollande urged the ECB and Germany to do more to boost growth and fight a "real deflationary risk" in Europe.