November 25, 2014

Euro zone yields hit lows: Is ECB trumping reality?

It's hard to believe it's just a few years since countries like Ireland and Spain had to go cap-in-hand to international lenders - at least if you look at their bond yields.

Ireland's 10-year bond yield (Exchange: IE10Y-IE), usually reflective of a country's economic performance, hit a record low of 1.477 percent Monday, while Spanish 10-year bond yields (Spain: ES10Y-ES) fell below 2 percent for the first time ever.

Ireland is expected to have one of the strongest economic rebounds in the euro zone, with 3.7 percent growth in gross domestic product (GDP) this year, according to Deutsche Bank forecasts.

Yet it is also facing plenty of headwinds.There are increasing concerns that the current administration may not last for its maximum five-year term, as disputes over water charges and the recording of phone calls to police stations have destabilized the coalition.

Taoiseach Enda Kenny's Fine Gael party would get just 22 percent of the vote now, down from 36 percent in the 2011 elections, according to a Red C/Sunday Business Post opinion poll published at the weekend.

Polls suggest a large swing towards Sinn Fein, formerly better known as the political wing of the Irish Republican Army but now a growing voice of dissent from the main parties in Dublin.

Independent candidates, often campaigning in direct opposition to a single government policy, have also been boosted by the waning popularity of the two traditionally dominant parties, Fine Gael and Fianna Fail.

The troika of the International Monetary Fund, European Commission and ECB, who bailed-out Ireland and its banks during the credit crisis, warned on Friday that its current budget "makes less progress than desirable" towards reducing its budget deficit - and that its recovery is at risk if there is a further slowdown in the euro zone.So why buy Irish bonds when they're already paying less than they have ever done?

These bond spreads now look "extremely tight relative to longer-run valuations and the weak cyclical backdrop for the euro area economy" according to strategists at Barclays. The answer lies, as so much does, with ECB President Mario Draghi.

He seemed to lean closer to launching a program of quantitative easing, potentially including the purchase of sovereign debt (i.e. possibly Irish bonds) in a speech on Friday. This would be part of the ECB's ongoing attempts to combat potential deflation in the region.

An "explicit announcement that the ECB is prepared to undertake a large-scale asset purchase program (including sovereign debt)" is now likely at the ECB meeting on 4 December, according to economists at Credit Suisse.

Whether that moment comes in December or not, bond traders seem to believe that the ECB will continue to prop up peripheral euro zone economies.One of the most important forward indicators for future economic growth, the euro area flash PMI figures, came in worse than expected for November, led by weakness in Germany.

This was termed "another vote for public QE" by Deutsche Bank analysts. "All yields in the periphery are mad - Ireland less so because it's got more chance of surviving when winter comes. Winter is coming," warned Bill Blain, strategist at Mint Partners.

yahoo.com

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