For Ireland, Spain, and Portugal less than a decade ago, investors could barely be compensated enough to hold their bonds for fear they could be severed from the eurozone.
Now, investors are a hair’s breadth away from having to pay for the privilege.
An unprecedented surge in sovereign debt across the world has driven 10-year yields in the Iberian nations, as well as those in Ireland, to record lows of around and below 0%.
With about €14.5 trillion of global debt across the world now paying negative rates, investors are snapping up positive yields wherever they can find them — even if that means getting into some of the eurozone’s once riskier markets.
While that marks an extraordinary turnaround for countries once on the brink of bankruptcy, it also highlights a new era for bond markets where yields are perpetually low and central banks can do little to revive inflation.
And it comes with its own perils —the growing fear that a bond bubble is in the making.
“I am afraid all curves are going to zero and all rates are going to zero,” said James Athey, senior investment manager at Aberdeen Standard Investments.
“It would be an incredibly concerning signal,” Mr Athey said.
Yields have turned negative in the highest-rated eurozone markets, as pessimism deepens over global growth prospects.
The rally is also being fuelled by rising expectations of policy easing by the ECB.
The ECB should come up with an “impactful and significant” stimulus package at its next meeting in September, the Finnish central bank head Olli Rehn said last week.
“In a regime of financial repression, this is normal,” said Jorge Garayo, a fixed-income strategist at Societe Generale, referring to the ultra-low yields.
“The big question is how the whole thing unravels over time. Lower yields incentivise more borrowing when debt levels are already at high levels,” he said.
Ten-year yields fell below 0.1% in both Spain and Portugal last week — a far cry from highs of almost 8% and 18%, respectively, seven years ago when the nations battled a debt crisis and had to accept financial rescue packages from either the EU or the IMF.
For both countries, the yield spread over Germany, a key gauge of risk, touched a record low of 60 basis points last month.
Ireland’s 10-year bond sunk into negative territory a little longer.
The Irish benchmark bond was trading at minus 0.07% yesterday —having traded at around minus 0.15% last week, as investors became convinced that Germany’s flirtation with recession would spark a big response from the ECB next month.
The Iberian nations’ sovereign debt ratings are still well below those of top-ranked countries such as Germany, but they have recovered from the post-crisis lows.
Spain is currently rated Baa1, or three notches above junk, at Moody’s Investors Service, after being cut as low as Baa3 in 2012.
Portugal is now at Baa3, the lowest investment grade, after recovering from a drop into the junk category.
The two countries still have elevated levels of debt, an indicator of relatively high risk, with Spain’s liabilities amounting to 98% of output and Portugal’s running at 126%.
Iberian bonds have also drawn strength from the region’s economic comeback.
Despite patches of political uncertainty, such as the Catalonia crisis in 2017, the two countries have consistently posted some of the eurozone’s highest growth rates.
Portugal and Spain saw their economies expand 1.8% and 2.3% respectively in the year through June, compared to stagnation in Germany.
Additional support for Spanish and Portuguese bonds, as well as other eurozone bonds, has come from the ECB’s €2.6 trillion debt-buying programme, which guaranteed a buyer even during times of turbulence.
Portugal was kept in the programme after DBRS was the only rating agency that refrained from downgrading it to junk even as the country had to depend on an IMF bailout plan in 2011 to weather the crisis.
Peripheral bonds have also gained popularity with foreign buyers, particularly from Japan, for whom the yield pickup gets a boost when hedged against currency swings.
Spanish 10-year bonds offer a 50-basis-point premium compared with Japanese domestic bonds, while Japanese investors snapped up the most Italian securities since 2005 in June.
“The Iberian countries have made great economic progress year after year,” said Ruediger Kerth, a portfolio manager at Union Investment in Frankfurt.
“The outlook remains promising.”