4/27/2014 0 Comments
European bond contraction
European yields have hit lows not seen since the crisis, with countries like Portugal and even Greece having successful auctions. Spain has the ability to borrow cheaper than the US and Italy can borrow money for a little more than 2% over German bunds. This phenomenon has been attributed to the economic recovery of the region, disinflation, and speculation or a large scale buyback by the ECB. One thing that is for sure is the entire developed world has somewhat equalized in terms of returns from fixed income assets. Should the ECB start a large scale buyback these yields may drop further, but not by much (if the US is any guide yields will have hit their lows prior to the start of QE). If deflation sets in the underlying economies of these bonds will no doubt suffer and a crisis could result, widening the spreads. In either scenario yield hunting in the developed world is near saturation, getting a foothold in the EM space could set you up for sizable gains in the years to come.
Political unrest and a pullback in FDI plagued EM currencies over the past year and the start of this one. This could provide opportunities in regions that would directly benefit from increased stimulus in the EU. With Russia having more sanctions placed on it as a result of the Ukraine crisis that play should be reserved for a more risky play on geopolitical tensions easing (though I do feel there is opportunity for longer term investors). Turkey is a region that I feel could benefit from declining yields in Europe and stimulus should Draghi decide to take action (and eventually he will have to).
The region has been shunned since the protests leading up to the elections in favor of better prospects in the developed markets, mainly Europe. Now with yields at record lows many of the companies in Turkey can issue Eurobonds (Finansbank just borrowed $500mln last week) denominated in Euros and should be able to attract investors for yields much lower than the rate in Turkey. Should the ECB try to stoke inflation with QE or negative interest rates (a more likely scenario in the near term) investors searching for yield will be enticed by the emerging markets that have been raising rates to stem outflows.
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