European Investors Bet on Central Banks to Keep Bond Party Going

(Bloomberg) -- European bond investors are putting their faith in the purchasing power of central banks, as political crises in two countries threaten to overshadow another deluge of debt sales next week.

Italy’s bond holders are wobbling in confidence after the departure of a junior partner from Prime Minister Giuseppe Conte’s coalition raised the prospect of fresh elections this summer. That pushed up the yield spread over Germany, a barometer of risk, by the most since June in the past week, while Dutch bonds weathered plans by Prime Minister Mark Rutte’s government to resign.

Most analysts expect the European Central Bank’s pandemic stimulus buying to mean spreads avoid the kind of blowouts seen in previous bouts of political chaos. The ECB is seen leaving that policy on hold when it meets Thursday, yet its recovery program has the flexibility to weight purchases toward a particular country if needed.

President Christine Lagarde is likely to be asked about Italy -- after causing market turmoil last March by saying the ECB wasn’t there to close spreads. The country’s yields touched record lows this month and were set to be the darling of the region this year.

“While the ECB stands ready to do more, the hawks are putting limits to what the central bank can agree on,” said Jan von Gerich, chief strategist at Nordea Bank Abp, who doesn’t expect any major decisions to be made in the first few meetings of this year. “Such a stance also leaves some room for yields and spreads to increase.”

The ECB’s pandemic bond buying program saw purchases fall to less than half the historical average in a holiday-shortened first week of the year. But it can still rely on the 1.1 trillion euros ($1.3 trillion) remaining in its armory that must be used by the end of March next year. Citigroup Inc. calculates it will buy 66 billion euros more of Italy’s bonds this year than will be sold, after accounting for redemptions.

Its strategists are counting on that to bet Italy’s yield premium over Germany will narrow back to 110 basis points, from 115 basis points currently. Commerzbank AG analysts aren’t expecting a snap election and are sticking to a 75-basis-point target for the spread.

Rate Bets

Conte will face a confidence vote in the Senate on Tuesday after losing his parliamentary majority. In the Netherlands, Rutte’s government will resign after he failed to win the backing of coalition allies, though investors seem unperturbed. An election was already due in March and he will stay on in a caretaker capacity.

Investors will also be closely watching Bank of England Governor Andrew Bailey on Monday and Wednesday for possible clues on sub-zero rates. His comment last week that there are a lot of issues with negative rates spurred traders to sell gilts and push easing bets back to December, from August.

The central bank’s Andrew Haldane speaks on Tuesday. In October he said that while negative interest rates were being studied, it didn’t mean that they would be implemented. Norges Bank also meets Thursday, with the krone taking an early lead as the top performing G-10 currency this year on bets the country might signal a lift to rates.

Week Ahead

Euro area conventional bond sales are scheduled from Germany, France, Finland and Spain totaling 18 billion euros, according to Citigroup. Danske Bank A/S expects the EU, Greece, Portugal and possibly Italy to sell bonds via banks next week. There are no redemptions or coupons payable.

The U.K. will hold one regular gilt auction for up to 3.25 billion pounds and sell a 25-year bond through banks. The BOE will buy back 4.4 billion pounds of debt in three operations. Around 28 billion pounds from coupons and a bond redemption will be paid on Friday.

• Euro-area, German, U.K. and French preliminary manufacturing and services PMI data for January are due Friday
• The data schedule is otherwise light with the euro-area publishing consumer confidence figures for January on Thursday and Germany’s January ZEW survey numbers due Tuesday
  • U.K. December inflation numbers will be published Wednesday and retail sales figures for December Friday
• A quiet period for policy makers is in place ahead of the ECB rate decision on Jan. 21, meaning there are no speakers scheduled until Lagarde’s press conference after the outcome. The ECB publishes its survey of professional forecasters Friday
• Fitch Ratings is scheduled to review Greece, EFSF and ESM, DBRS Ltd. to review the Netherlands, EFSF and ESM on Friday