It’s Too Soon to Sell Into Rally for Standard Life: Euro Credit

Jul 30, 2014 4:54 am ET

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July 30 (Bloomberg) -- For Standard Life Investments Ltd., a beneficiary of the rally in higher-yielding European government bonds, the securities may be starting to look expensive. Just don’t head for the exit yet.

“We’ve gradually moved out on the risk spectrum to the point where we’ve had a lot of peripheral bonds and that’s paid us quite well,” Frances Hudson, a strategist at the Edinburgh- based company, which manages about $325 billion, said in an interview. “The question is whether that has gone too far and perhaps they are not now accurately reflecting the risks.”

Standard Life’s position illustrates the predicament for bondholders in the euro region. Even as many judge yields have fallen too far, too fast, they are unwilling to bet against the market on prospects that further stimulus from the European Central Bank will push rates even lower. The risk is that buyers will be hard to find in the event of a selloff, underscored this month when financial concerns at one of Portugal’s biggest banks roiled markets.

Government bonds extended their rally yesterday, with 10- year yields from Germany to Spain falling to records.

Spanish yields are down more than five percentage points from their highs at height of the sovereign debt crisis. The rate slipped to 2.46 percent yesterday, the lowest since Bloomberg started collecting the data in 1993. Those on similar- maturity Italian securities dropped to 2.63 percent, from as much as 7.48 percent in 2011.

Lagging Economy

The moves are both a tribute to the credibility of ECB President Mario Draghi’s 2012 pledge to safeguard the euro and a signal of pessimism that the measures that stabilized markets will be enough to stave off deflation and boost economies. Analysts predict the euro region will underperform its developed-nation peers in the three years through 2016.

Reports tomorrow may add to the impetus for more stimulus and extend the market’s upward trajectory.

The inflation rate in the euro region stayed at 0.5 percent for a third month in July, less than half the ECB’s target, according to the median prediction of economists in a Bloomberg survey before the release. Another report will show the jobless rate remained at 11.6 percent in June, a separate survey showed. Data today may show economic confidence in the euro area declined last month, economists predict.

‘Deflation Worry’

The ECB cut its main refinancing rate to a record low 0.15 percent on June 5 and decided to start charging banks a fee in the form of a negative deposit rate for parking cash with it overnight. It also said it would introduce a program to encourage banks to lend.

“There is obviously a worry about deflation,” said Grant Peterkin, a Geneva-based senior portfolio manager at Lombard Odier Asset Management, which runs about $48 billion. “If you believe there is a deflation risk around Europe, then there is some value in owning European bonds on a tactical basis.”

Peterkin said yesterday he holds a “small amount” of Italian bonds and favored German bunds at current levels. The securities of Europe’s largest economy are perceived to be among the region’s safest and tend to rise in times of turmoil.

For now, the rally that has seen Greek bonds deliver a 29 percent return this year while Portuguese debt made 16 percent, shows no sign of abating.

Portugal’s 10-year yield was at 3.59 percent yesterday, having dropped to 3.55 percent on July 28, the least in a month. The rate climbed to 4.02 percent on July 10 after companies linked to Banco Espirito Santo SA missed short-term note payments. Even at the height of that selloff the yield was less than a quarter of its record 18.289 percent in 2012.

“With European bonds, it’s still a slight overweight, not a big overweight,” said Hudson at Standard Life, Scotland’s largest fund manager after Aberdeen Asset Management Plc. She confirmed yesterday that the rally hadn’t prompted the firm to sell European bonds. “It’s an overweight, but a very vigilant position.”