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Europe's Riskiest Countries Find Debt Markets Wide Open

10/20/2020 | 07:15am EST

By Anna Hirtenstein

Borrowing costs for Europe's riskiest governments are hitting record lows as investors bet on newfound European political cohesion. Also pushing yields lower are U.S. election dynamics reverberating across the Atlantic.

Yields on 10-year benchmark debt of Italy and Greece dropped to all-time lows last week, both well under 1%. In a sign inventors see fewer risks among eurozone members, Southern European yields have converged to the narrowest point in years with those of Germany, considered the safest in the region.

Greece's borrowing costs shrank to the tightest point relative to Germany since 2009 last week, a flashback to before last decade's eurozone debt crisis exposed financial fault lines across the Continent. Italy's are at their lowest since 2018.

The dwindling differentiation in borrowing costs among European nations is a remarkable turn. In March, those yields spiked, rekindling fears that the eurozone's various members wouldn't hang together through the coronavirus crisis.

Instead, investors have flooded into European debt, having grown comfortable with the European Central Bank's and the European Union's response to the pandemic. A pan-EU stimulus plan, in which all the nations share the financial burden, is seen as a leveler for the worst-hit economies, which also happen to be the most indebted.

Europe's riskier government bonds rallied further in recent weeks. Slipping growth and inflation in the face of a second round of Covid-19 lockdowns have raised expectations that the ECB will boost its stimulus at coming meetings.

Another factor far from Europe is improved poll numbers for Democrats in the coming U.S. election. This has prompted some investors to reassess their view of Treasurys, making European government bonds more attractive. Bond prices rise as yields fall.

"What markets are focused on is the widening in the polls, [Democratic presidential candidate Joe] Biden pulling ahead by a greater margin," said Scott Thiel, chief fixed-income strategist at BlackRock. "It's bullish for stocks and bearish for fixed income. If you're a European investor who's opportunistically invested in the U.S., this outcome might shift you back to European assets."

While election results in 2016 caught investors off-guard, markets are factoring in the possibility that Democrats will win the White House and both chambers of Congress. That would smooth the way for stimulus spending plans to materialize quickly.

In theory, another jump in government spending would mean an increase in supply of U.S. government bonds and faster growth. That could depress bond prices and send yields up on Treasurys, though the Federal Reserve's aggressive bond buying has kept a lid on yields this year.

Jon Jonsson, a fixed-income portfolio manager at Neuberger Berman, has sold off longer-dated Treasurys and bought more Southern European government debt, which still has a positive yield. He bets there could be a "repricing of Treasurys" if a big stimulus bill is passed under a new administration.

Yields on 10-year Treasury notes have edged up in recent weeks to 0.76% Monday, near their highest since June.

While both Europe and the U.S. have enacted big financial responses to the pandemic, the market is focusing on the differences in order of magnitude. The Democrats' multitrillion-dollar spending plan dwarfs the EU's recovery package of EUR750 billion, equivalent to about $879 billion.

"While fiscal policy is easy all around the world, no other developed market is looking at this kind of level," besides the U.S., said Seamus Mac Gorain, head of global rates at J.P. Morgan Asset Management.

Also favoring European bonds is a quirk of derivatives markets. The spread on three-month euro-dollar basis swaps, a contract that traders use to hedge risk when they lend in one currency and borrow in another, has turned negative since late August. This means investors who mainly use dollars can earn a relatively higher return by owning European bonds.

To be sure, there are risks to the current dynamic, including an uncertain election outcome in the U.S. or a double-dip recession as coronavirus cases mount. The U.K. and EU also remain at loggerheads over a post-Brexit trade deal to replace a transitional agreement that expires at the end of the year.

Lower yields have helped European governments raise funds at record-low costs. Italy issued one of its mainstream government bonds with a zero coupon for the first time on Oct. 13. The yield on its benchmark 10-year debt reached an all-time low of 0.639% the day after. The Greek equivalent also plumbed new depths, reaching 0.763%. Earlier this year, Italy's yield was close to 3% and Greece's was above 4%.

Write to Anna Hirtenstein at anna.hirtenstein@wsj.com

(END) Dow Jones Newswires

10-20-20 0714ET

Stocks mentioned in the article
ChangeLast1st jan.
BLACKROCK, INC. 0.22% 706.55 Delayed Quote.39.97%
EURO / BRITISH POUND (EUR/GBP) 0.29% 0.89417 Delayed Quote.5.30%
EURO / US DOLLAR (EUR/USD) 0.22% 1.1937 Delayed Quote.6.23%
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