German bonds are more attractive than ever as a haven from Europe’s debt crisis after Standard & Poor’s stripped France and Austria of their AAA ratings and said regional leaders aren’t doing enough to end the turmoil.
Two-year German yields that have tumbled to as low as 0.134 percent from last year’s high of 1.95 percent will keep drawing investors seeking safety, according to Credit Agricole Corporate & Investment Bank and Royal Bank of Scotland Group Plc. S&P’s warning that financing costs for some nations may remain elevated could sap investor appetite as France and Spain prepare to sell debt this week. Germany will auction two-year notes.
“S&P’s action has reinforced the market’s view that the only haven in the euro-region bond market is Germany,” Peter Chatwell, a fixed-income strategist at Credit Agricole Corporate & Investment Bank in London, said in an interview Saturday. “There’s still a lot of uncertainty in the euro zone. Bund yields will stay at these low levels and, in spread terms, France could drift wider,” he said, referring to the extra yield investors demand to hold French debt instead of bunds.
S&P announced after financial markets shut on Friday that it cut the credit ratings of France and Austria by one level to AA+ and warned they may face further reductions. Italy, Portugal, and Spain were lowered by two steps as a total of nine nations were downgraded. While the Netherlands, Finland and Luxembourg kept their top ratings, they were given a “negative” outlook.
The lower ratings add to the challenges facing European leaders as they struggle to tame a sovereign debt crisis now in its third year. Turmoil in the region’s debt markets and swelling budget deficits are damping business and consumer confidence around the world and threatening to stifle the global economic recovery.
Germany’s 10-year yield dropped by the most in four weeks on Friday amid speculation S&P was poised to downgrade the debt of several European nations, including France. The 10-year German yield fell seven basis points, or 0.07 percentage point, to 1.77 percent, approaching the record low 1.636 percent set on Sept. 23. It was little changed at 1.77 percent at 8:16 a.m. London time.
The two-year German note yield was at 0.15 percent, after sliding to an all-time low 0.134 percent on Thursday. Bund futures were little changed, with the front contract at 139.86, after rising to a euro-era high 140.23 on Jan. 13.
French 10-year yields climbed five basis points to 3.12 percent. The extra yield investors demand to hold the securities instead of German bunds widened four basis points to 135 basis points, compared with an average of 69 basis points over the past year.
The additional yield on Austria’s 10-year bonds over similar-maturity bunds was 131 basis points, and the Italian- German spread widened 12 basis points to 499 basis points, versus a 12-month average of 284 basis points.
S&P acted at the end of the week in which Italian and Spanish bond rallied amid optimism the worst of the crisis was over and after the European Central Bank said it had quelled a credit crunch in the region’s banks.
European government securities had their best month on record in December after Italy and Spain appointed new prime ministers and investors bet the ECB would step up buying the region’s debt to cap yields. The central bank agreed to provide banks with 489 billion euros ($620 billion) of three-year loans on Dec. 21 in an unprecedented move to ease the crisis.
“This is a reality check after the recent improvement in sentiment,” Nick Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets Ltd., a broker for banks and investors, said in a telephone interview on Saturday. “It is certainly going to make things more difficult for the Spanish auction this week, and investors might be a bit more cautious before the other supply.”
Even after rising four basis points on Friday, Italy’s two-year yields still dropped 80 basis points last week to 4.30 percent, the lowest weekly close since October. Spain two-year rates declined 53 basis points during the week to 3.06 percent.
France plans to sell as much as 8.7 billion euros of bills today, and it will offer notes due in 2014, 2015 and 2016 and inflation-linked securities on Jan. 19. Spain will auction bills on Jan. 17, and debt maturing in 2016, 2019 and 2022 on Jan. 19.
Germany is scheduled to auction 4 billion euros of two-year notes on Wednesday. The nation sold six-month bills at a negative yield for the first time on Jan. 9 as investors sought safety from the debt crisis.
Demand for longer-maturity German debt has been less robust amid concern the securities are becoming overvalued. Investors bid for just 64.8 percent of the 6 billion-euro maximum target at a 10-year sale on Nov. 23.
German bonds maturing in more than a year have returned 11 percent in the past 12 months, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. While trailing the 19 percent return from U.K. gilts, they beat the 5 percent gain from French debt and 4.9 percent loss from Italian bonds.
S&P’s downgrades may be followed by others, said Laurent Fransolet, head of fixed-income strategy at Barclays Capital in London, in a note to investors on Saturday. Fitch Ratings on Dec. 16 lowered its outlook on France and put all the euro-region’s non-AAA rated countries on review for possible downgrade.
Demand for bunds may also be supported as Europe’s economic outlook deteriorates. The euro area’s gross domestic product will shrink 0.2 percent this year, while the U.S. economy will expand 2.3 percent and the U.K. will grow 0.6 percent, according to Bloomberg News surveys.
“Germany comes out as a clear winner” from the S&P announcement, RBS strategists including Harvinder Sian in London wrote in an investor note on Friday. “We continue to expect the crisis to deepen eventually leading to further widening in spreads across countries vis-a-vis Germany.”
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