By Anna Hirtenstein
Investors are lapping up a record amount of Southern European sovereign debt in a hunt for yield, while counting on the region's central bank to backstop the riskiest bonds.
Italy raised EUR16 billion ($17.3 billion) in late April in its largest-ever syndicated deal, through the sale of both five-year and 30-year bonds. A day later, Spain set a record selling EUR15 billion of 10-year debt.
That might be just the start. The coronavirus pandemic has dealt a hard blow to countries already wrestling with high debt loads and faltering economic growth. One of the worst outbreaks has been in Italy, where a strict lockdown brought its manufacturing sector to a near-halt. That is forcing governments to raise funds to revive their economies as the eurozone heads into its worst-ever recession.
Italy and France might raise more debt in 2020 than they have in any of the last 30 years, according to forecasts from UniCredit SpA. Spain is expected to issue its most since the 2008 financial crisis.
"The response from investors has been so strong, it tells you that the market seems not to be worried," said Keith Price, head of primary debt issuance for sovereigns, supranationals and agencies at JPMorgan Chase & Co.
But there are signs emerging that national debt-management offices are becoming less confident about demand for their bonds, according to Jorge Garayo, a fixed-income strategist at Société Générale.
Italy, Spain and even Germany recently opted to sell their bonds through syndication deals -- where banks are paid to drum up demand from investors, guaranteeing the sale of the full amount -- rather than auctions.
"We just had an incredible few weeks in bond markets," said Mr. Price. "But without the stimulus and the policy in place, there's no way that could have happened."
Italy is among the countries stepping up their government spending to offer stimulus to the economy. That is likely to push its ratio of debt to gross domestic product to 167% this year, up from 135% at the end of 2019, according to UniCredit. The mounting debt load is raising alarms: The extra yield that investors demand to hold Italian sovereign debt over German bunds has widened to 2.1 percentage points.
In response to the looming economic crisis, the European Central Bank in March said it would start a new EUR750 billion bond-buying program to offer relief to both governments and businesses by lowering borrowing costs. That program has had limited success, though the aggressive action helped revive investors' appetite for Southern European government debt at the time. The ECB's bond purchases were also challenged by a top German court earlier this month.
ECB officials have pledged in recent weeks to help rein in borrowing costs for weaker eurozone governments that are running up massive deficits while trying to save jobs and businesses.
The comments have given investors confidence that the ECB will do whatever it takes to keep Italy and Spain from defaulting, as that would pose a massive threat to the common currency. That is helping keep the Italian 10-year yield at about 1.68% on Monday, a far cry from the 7% level it breached in 2011-12.
"While there is an awful lot of [bond] supply that will be hitting the market, the scale of central bank purchases mitigates it," said Andrew Mulliner, a portfolio manager at Janus Henderson. Most investors are expecting the central bank to increase its bond-buying program, even "expecting it to double or more over the course of the year," he said.
Investors nevertheless appear willing to overlook the risks in part because years of low interest rates and cheap money flooding financial markets have shrunk the returns on the world's safest government bonds: The yield on 10-year German bonds was at minus 0.47% on Monday. For Japanese bonds, it was minus 0.006%, while U.S. debt was at 0.741%.
"We're in a negative interest rate environment and it doesn't look as if interest rates are going to be moving higher, therefore it does become about that search for yield," said Mr. Price.
Even the most conservative investors, including pension funds and insurers, have been channeling more funds into riskier securities, such as junk-rated bonds, stocks and alternative investments, in recent years to generate better returns.
However, the central bank alone can't get Europe through the crisis, according to Fabian Zuleeg, chief executive officer of the European Policy Centre, a Brussels-based think tank. There also needs to be an agreement reached by the European Union leaders to share the economic burden, he said, a historically controversial issue that has re-emerged as a point of pressure in recent weeks.
--Pat Minczeski contributed to this article.
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