Italian bonds were the biggest gainers among euro-area sovereign securities in the wake of China’s riposte to the U.S.’s imposition of tariffs. That’s despite Italy still lacking a working government since its March 4 election, and German bunds traditionally being the go-to haven for investors in periods of heightened risk-off sentiment.
That’s from a Bloomberg piece out on Thursday that documents the extent to which periphery debt has become an “unlikely” safe haven at a time when the world is teetering on the edge of a trade war thanks largely to one “very stable genius” and his not-so-merry band of accomplices in Washington.
Here’s the yield spread between the safest of safe havens (bunds) and Italian 10s:
Of course as we noted earlier in a tweet, BTPs have gotten more than a little support from a certain central banker who has pledged to everywhere and always do “whatever it takes” to make sure the periphery doesn’t lose market access like it nearly did during the European sovereign debt crisis.
Well, in light of this discussion, it’s worth taking a look at some of the highlights from BofAML’s latest European credit investor survey, that finds Barnaby Martin reminding you that “next year will be the first since 2016 in which credit investors will have to navigate markets without the helping hand of ECB asset purchases.”
Of course this is a survey of corporate credit investors, but this is all inextricably linked and not just because part of ECB QE is corporate bond buying. QE drives investors down the quality ladder whether that’s into high yield debt on the corporate side or into riskier sovereigns in government bonds. And there is of course evidence that the ECB has deviated from the capital key at critical junctures in order to keep a lid on borrowing costs amid political turmoil.
Well as it turns out, euro IG investors’ biggest worry is now “quantitative failure” – that’s a notable shift from February, when the biggest concern was inflation:
As Martin notes, “the speed at which inflation concerns have flipped highlights the slim margin of error for a ‘goldilocks’ economic backdrop in ’18.” Too much inflation pressure risks forcing the ECB to withdraw stimulus faster than the market expects while a sudden deceleration in the data (which we’ve gotten some evidence of lately) would present the opposite problem. Here’s Martin again:
After fretting about inflation at the start of the year, April’s credit survey shows that the biggest concern has reverted back to “Quantitative Failure”, driven by the recent data slowdown. Investors say that a lack of inflation traction into year-end – just as the ECB, for political reasons, has to end QE – could form a toxic combination. The result is that markets are likely to get nervous again about debt sustainability, especially around the European periphery. In fact, since Global Financial Crisis, monetary largesse from central banks has simply added to the world’s debt level by almost $50tr (~40%). And inflation remains key to solving a debt “problem” when bond restructurings and haircuts are no longer palatable.
There you go – that kind of ties everything said above together and puts a nice bow on it. Here’s the chart that shows a world awash with debt making inflation “a must”:
That said, it can’t be emphasized enough that too much inflation too quickly would present its own disaster scenario as it would potentially force central banks to withdraw transparency with markets. This is the “slim margin for error” mentioned above.
As far as the breakdown of the biggest risks in the eyes of both IG and HY investors in Europe, here are the updated visuals on that:
And finally, here’s a breakdown of the responses BofAML got when they asked about protectionism and trade wars:
Amusingly, HY investors seem to be more pessimistic about the chances of a material escalation in trade tensions stemming from the recent “skirmish” kicked off by the Trump administration.