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Low-coupon bonds preferred in stressed markets
March 17, 2013
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LONDON: Chinks are showing in the Italian bond market’s resilience to the political stalemate that followed last month’s election. 

Backstopped by the European Central Bank’s bond-buying pledge, Italian yields have been relatively steady at levels well below their all-time highs since the Feb 24-25 vote which left parties deadlocked over how to form a government. But some potential signs of market stress are emerging. 

Italian bonds paying lower rates of interest have outperformed higher-coupon paper of similar maturity in recent weeks - a phenomenon that occurs in times of heightened uncertainty, when investors take defensive positions.

“It is one of the crisis barometers,” said Commerzbank rate strategist David Schnautz. “When you have stress in the system you see certain dislocations, switches in the curve.”

While yields on the two types of bonds are similar, those offering smaller coupon payments are generally cheaper to buy, reducing the potential loss for the investor if the issuer cannot repay its debts.  

A sovereign borrower with liquidity problems would also be more likely to delay coupon payments than not redeem the bond at maturity, analysts say.

The discrepancy in price is most visible at the longer end of the Italian debt curve, where the difference between coupons is also wider.

A bond maturing in August 2023 and carrying a 4.75 per cent coupon was priced at 101.53 cents in the euro this week, while a November 2023 bond paying a coupon of 9 per cent was priced at 134.87 cents in the euro.

The August bond has outperformed in recent weeks, widening  the difference in yields between the two bonds so that the higher-coupon November paper currently offers investors an additional return of about 21 basis points.

That is the biggest differential since early January and a jump from just 10 basis points - the smallest gap since December 2010 - before last month’s vote, although still well off wides of more than 100 basis points hit at the end of 2011.

Then, with former Prime Minister Silvio Berlusconi still at the helm, Italy’s borrowing costs soared to unsustainable levels and markets feared its debts would spiral out of control.

 Yields have since fallen sharply, with the ECB’s as-yet untested pledge in September to buy bonds of eurozone countries that seek aid underpinning valuations.    

“In the old days the difference was very pronounced. I’m not saying we’re heading towards that now, I’m just saying it’s something we need to watch,” Schnautz said.

In France, regarded by investors as one of the eurozone’s safest credits, the yield differential between similarly-dated bonds has been more stable. 


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