Grant's Interest Rate Observer

Dispatches from the upside down

Talk about lower-for-longer:  Ewald Nowotny, governing council member of the European Central bank, told Austrian public broadcaster ORF in a radio interview today that the ECB will keep its benchmark deposit rate on the far side of zero (it’s currently minus-0.40%) not only through the end of this year, but through next year as well.  “Realistically speaking, from this perspective, there will only be a change in interest rate policy in the year 2019,” said Nowotny.  

Readers of the ECB tea-leaves expect more EZ monetary policy: Quantitative easing (albeit at a slower pace. The ECB is set to taper its current €60 billion monthly purchase pace to €30 billion in January) and negative interest rates aren’t going anywhere for the time being.  “We change our ECB call,” declares Johnny Bo Jakobsen, strategist at Nordea Markets: “We now expect the ECB to extend QE once more and the first rate hike is not seen until 4Q 2019. Thus, we no longer anticipate a deposit rate hike in 1Q 2019.”
 
The Kingdom of Spain is taking its cues accordingly. The Iberian nation today announced plans to sell bonds next week in four maturities: 2021 at a 0.05% coupon, 2022 at 0.45%, 2027 at 1.45% and 2066 at 3.45% (size is still to be determined).   For comparison, France, which is rated Aa2 at Moody’s (the third highest rung on its scale) borrows for 10 years at a 1.00% coupon.  Spain, which already has existing 1.45% coupon bonds due in 2027 (they are trading a bit below 99 cents on the euro) is situated at Baa2 at Moody’s, just two notches above junk status.

On the ropes through the eurozone debt crisis of 2010 to 2012, Spain has enjoyed a resurgence in economic growth in recent years.  GDP has expanded by more than 3% on a year-over-year basis in 10 straight quarters going back to June of 2015, although growth is starting to wane. The trailing four quarter average advance of 3.1% year-over-year is down slightly from 3.4% in the four quarters prior.

Political unrest has gripped the Kingdom of late, with the early-fall secession movement undertaken by Catalonia (its most prosperous region) being met with a heavy handed response from Madrid, including the imposition of direct rule. Today a Spanish Supreme Court judge set bail for five Catalonian parliament members who have been cooling their heels in jail on charges of sedition related to the Oct. 1 independence referendum. Prime Minister Mariano Rajoy told reporters yesterday that the strife could lead to lower growth:  Indeed the government already revised its 2018 GDP forecast to 2.3% from 2.6%.

A substantial recent divergence in the Spanish Leading Indicators Index with GDP lends additional credence to the idea of an upcoming decline in growth.  

While growth looks set to decline, inflation is stirring.  The year-over-year change in Spanish CPI has jumped to an average of 2.1% in the 10 monthly readings seen this year.  By contrast, 2016 and 2015 averaged year-over-year changes of negative 0.2% and negative 0.5%, respectively.  Among the new issues, only the bonds maturing in 2066 offer a positive real return at that 2.1% rate of inflation.

For investors seeking alternatives, a pair of trades immediately come to mind.  The Stoxx Europe 600 Index, which trades at just under 21 times trailing earnings and just over 16 times estimated 2017 earnings, sports a relatively princely dividend yield of 3.28%.  If sovereign fixed income is what fits the bill, then how about 10-year U.S. Treasury notes, priced at a yield-to-worst of 2.40% and bearing a triple-A rating from Moody’s.

The ECB wants them?  Let have the ECB have them.