Main market events
Eurozone purchasing managers indices disappointed on Thursday. Hopes that a rebound in Chinese growth would rescue the European manufacturing sector, for now seem to be idle. Surprisingly also the service sector disappointed. An indication that domestic economies could also be facing some headwinds. In this cloudy environment peripheral bonds, with the exception of Ireland, lost some ground and spreads versus Germany widened slightly. Italian bonds have returned 1.8% year-to-date, Spanish bonds 2.9%, Portuguese bonds 3.9% and Irish bonds 2.8%.
Elections on Sunday April 28th, are unlikely to find a decisive result and coalition building could become a cumbersome process. Some moderate fiscal slippage in case of a left-of-center coalition, and the possibility of some re-escalation of the Catalan crisis in case of a right-of-center government, are seen as the predominant election risks. As Spain has recently been outperforming, some consolidation of yield-spreads vis-à-vis its peers seems likely.
Italy’s fiscal outlook continues to grab the headlines. On Tuesday the Bank of Italy reported that - should the government cancel the VAT hike planned for 2020 - the budget deficit would be pushed towards 3.4% of GDP next year. Weakening growth and rising borrowing costs are exposing Italy’s fiscal vulnerability further. On Friday April 26th, S&P will update Italy’s rating, currently at BBB, outlook negative. S&P needs to discount the recent economic and fiscal deterioration and although not a base case, a downgrade to BBB- cannot be excluded completely.
Although the ECB hopes that Eurozone growth will rebound, it is preparing for the eventuality it does not, and the central bank needs to deliver further stimulus and/or keep interest rates in negative territory for much more time to come. In this regard it is interesting that there seemingly remains skepticism on the governing council about the benefits of a potential shift towards a tiered deposit system.
Robeco Euro Government Bonds
As we expect volatility around the upcoming Spanish elections to increase we have reduced the funds exposure in very long dated Spanish bonds, switching into France, which may benefit from large redemptions next week. Moreover, after the recent risk-rally, Spain is now trading at the lower end of the 12-month spread-range versus France. Investments in peripheral bonds are at circa 33%, about 7% below the level of the index. Year to date the absolute return of the fund is 2.0%.*
* Robeco Euro Government Bonds, gross of fees, based on Net Asset Value, 18th April, 2019. The value of your investments may fluctuate. Past results are no guarantee of future performance.