No Relief for Europe's Bonds

 

 

By Matt Phillips And Jonathan House 

 

 

 

 

 

A selloff in euro-zone bonds continued on Monday, as investors shrugged off the election of a fiscally conservative government in Spain and continued to clamor for bold action by European policy makers.

A day after Spain's Popular Party won a sweeping victory over the ruling Socialists in the general election, Spanish borrowing costs approached their highest levels since the European debt crisis began. Italy's 10-year yield continued to rise, as did yields for Portugal, Ireland and Greece. The yields on the highest-rated European bonds also pushed upward, with the Netherlands, Austria, Finland and France all rising.

With few signs that the European Central Bank is willing to significantly beef up its purchases of euro-zone bonds to stabilize the market, investors world-wide continue to dump bonds of heavily indebted euro members and snap up U.S. Treasurys and the benchmark for safety in Europe, the German bund.

Europe's prescription for solving the crisis has focused on forcing vulnerable countries to cut public spending. Yet that course, championed in particular by Germany, has done little, if anything, to win back investor confidence.

"There's a growing recognition that austerity alone is not going to solve the problem," said Stuart Thomson, chief market economist for Ignis Asset Management. But equally, he said, "there's a growing recognition that the ECB cannot solve the problem. Those who are looking for a miracle with unlimited (money printing) from the ECB are misguided. To believe in that is to believe in Santa Claus."

The relentless selling pressure in Europe underscores a simple, difficult truth. Euro-zone governments—excluding Ireland, Greece and Portugal, which have already been cut off from the markets—need to borrow roughly €800 billion ($1.08 trillion) in 2012 to repay maturing debts and fund their operations, according to Barclays Capital estimates. But investors, who in normal times were more than willing to lend, are increasingly turning up their nose at all but the safest-looking European nations that want to borrow.

"Hedge funds are not there anymore. Banks are pulling out. You have ordinary fund managers not being active anymore. You haves central banks reducing risk," said Peter Schaffrik, head of European rates strategy at RBC Capital Markets in London.

Monday brought fresh reports that some of Japan's big investment trusts are turning away from European government bonds. Kokusai Asset Management Co. said it has sold all the Spanish and Belgian government bonds held by its Global Sovereign Open fund, the largest investment trust in Japan. Other risk-averse Japanese investors are taking a similar approach. Mizuho Trust & Banking Co. removed Italian government bonds from its overseas sovereign fund targeting individual investors in September.

Closer to home, large French banks BNP Paribas SA, Société Générale SA and Crédit Agricole SA have reported in recent weeks that they have chopped exposure to government bonds in troubled euro-zone countries in recent months.

Such departures from the European bond market—whether a short-term or long-term phenomenon—have made it increasingly difficult for buyers and sellers to agree on prices recently, prompting calls for the ECB to boost its buying of sovereign debt to keep market conditions orderly.

"In the very, very near term, you need to stabilize the prices and there's only one entity that can do that and that's the central bank," said Scott Thiel, head of European and non-U.S. fixed income for BlackRock in London.

The postelection slump of Spanish bond prices Monday, as well as persistently weak prices of Italian and Greek bonds, suggests investors may think the crisis has gone beyond the control of national governments alone and requires difficult, time-consuming alterations to the fabric of the euro zone. The yield on Spanish 10-year government bonds rise as high as 6.6% on Monday, before closing at 6.55%.

French yields nearly hit 3.62%, after Moody's analysts published a note saying that "elevated borrowing costs persisting for an extended period would amplify the fiscal challenges the French government faces amid a deteriorating growth outlook."

The ECB's reluctance to step up its limited bond purchases partly reflects a fear of a political backlash in Germany, where many lawmakers are already angry that the bank is intervening in government bond markets at all.

The German government repeated its view on Monday that the euro-zone crisis was caused by a lack of fiscal discipline and economic competitiveness in some nations on the euro periphery—and that the solution therefore lies in overhauls in those countries, not in ECB bond buying or collective European debt issuance.

Whether the ECB decides to boost its bond-buying or not, investors seem to be coming to the conclusion that any true solution to the European debt crisis will be a years-long process in which governments will be asking electorates to accept enormous sacrifices, in the form of entitlement cuts and tax increases, as well as weak growth and high unemployment.

This week, the European Union's executive arm will float proposals for joint issues of bonds among the currency's 17 governments. But Goldman Sachs analysts in a note Monday suggested such an approach "will take time, probably measured in years, for common issuance to start."

"It's all part of a process," said Stewart Cowley, head of fixed income of Old Mutual Asset Management in London, of any eventual solution to the crisis. "And if it goes wrong, all bets are off in Europe."wsj