Rising political uncertainty in Italy hasn't dimmed the
attractiveness of the country's government bonds maturing in the
next three years, while French bond prices don't adequately
compensate investors for the economic challenges plaguing that
country, a portfolio manager at Pacific Investment Management Co
said.
PIMCO, which runs the world's largest bond fund, expects Italian
debt to outpace gains in French bonds next year given the better
returns on offer, Miles Bradshaw, a portfolio manager at the London
office of PIMCO said in an interview.
"We are not positive on French valuations given the current
risks and the relative value of other assets. France offers less
yield than Italy and we expect this differential to narrow," Mr.
Bradshaw told Dow Jones Newswires.
Bonds sold by France, the euro zone's second largest economy,
have been resilient over the last year even as Spanish and Italian
bond prices tumbled. Yields on French bonds Monday plunged to their
lowest level since the start of the euro. By contrast, investors
currently demand yields of over two percentage points above what
they ask for French debt to buy two-year Italian bonds.
Mr. Bradshaw thinks the gains in French debt are not necessarily
a function of solid economic fundamentals. The European Commission
forecasts France's budget deficit for this year at 4.5% of gross
domestic product, compared to 2.9% of GDP for Italy.
Instead, the rally reflects the need to hold bonds for
regulatory reasons as well as buying from investors who are less
impressed with the even lower bond yields in countries such as
Germany.
"While France is a systemically important country in the euro it
faces a lot of structural issues--and over the course of the next
few years they will be running higher deficits than Germany which
will lead to a bigger net supply. There are more attractive assets
than French government bonds," he said.
PIMCO has been snapping up short-dated Italian and Spanish bonds
since the summer, buoyed by the European Central Bank's pledge to
buy government bonds with a maturity of three years or less under
its Outright Monetary Transactions plan as long as countries agree
to a monitored program of cost cutting. Many market participants
expect Spain to seek assistance sometime next year to unlock bond
purchases from the ECB.
"We have bought Italian and Spanish debt since the start of the
summer. Front-end valuations are more attractive given that the OMT
will do more to reduce volatility here," Mr. Bradshaw said.
But PIMCO is still cautious when it comes to longer dated
euro-zone bonds given the continued political risks in the
region.
Mr. Bradshaw said the firm will consider the price differential
between various bonds as well as the response of policymakers to
tackle the region's troubles before buying longer term bonds.
"We would get more conviction if we get the policy changes that
confirm euro zone policy-makers are getting ahead of the crisis.
This depends on what happens next in Frankfurt and Brussels," he
said, alluding to the headquarters of the ECB and the de-facto
capital of the European Union respectively.
Yields on Italian and Spanish bonds have plunged since ECB
President Mario Draghi said in July that the central bank would do
whatever it takes to preserve the euro. The announcement of a
revamped bond buying program followed soon after.
PIMCO enjoys enormous clout in financial markets; the firm
manages more than $559 billion of assets out of Europe. A vote of
confidence from such a large investor thus underscores the impact
of the ECB's bond-buy pledge and should reassure embattled
governments that overseas buyers will return as long as countries
take action to get their finances in order.
Some of the optimism in Italian bonds has been tempered in
recent days after technocratic Prime Minister Mario Monti said he
will resign as soon as the parliament approves next year's budget.
The euro zone's third-largest country is now expected to head for
polls as early as February, about a month earlier than previously
anticipated.
Mr. Monti's early resignation has stoked some concern that a new
government may abandon his reform agenda. Investors were also
rattled by the decision by former prime minister Silvio Berlusconi
to contest the election even though support for his party has
dwindled in recent months. Italian government bonds on Monday
suffered their steepest one-day loss since August, although they
have recovered somewhat since then.
Italy is set to be one of the busiest borrowers in the euro zone
next year with the government forecasting 410 billion euros ($531.6
billion) of bond and Treasury bill sales so retaining the interest
of investors is crucial. Mr. Bradshaw believes that politicians are
cognizant of the challenge and whoever replaces Mr. Monti will take
the necessary steps to avert a buyer's revolt.
According to polls, the centre-left coalition, led by Pier Luigi
Bersani, a cigar-smoking former minister, is currently the favorite
to form a government.
"We expect the Italian budget stability law to be passed,
probably by the end of the year. We also look to Pier Luigi Bersani
to win the upcoming election and to stay the course with Prime
Minister Mario Monti's reforms," Mr. Bradshaw said.
Write to Nick Cawley at nick.cawley@dowjones.com and Neelabh
Chaturvedi at neelabh.chaturvedi@dowjones.com
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