Investors in Ireland’s bonds are sitting on double-digit returns this year after a global debt rally and now they are starting to get nervous.
Fears of a bubble in bond markets have been growing on doubts over the extent of future monetary easing. In Ireland’s case, the UK’s political turmoil is an added hurdle as the neighboring economies are intertwined and a crash exit from the European Union could spark worries over credit risks.
So far Irish debt has been relatively immune to Brexit, which has sent the pound and Irish stocks slumping. Now that new British Prime Minister Boris Johnson is seeking an election to force through Brexit, some investors in the bonds are jumping ship.
“We generally see very little hard-Brexit risks priced into Irish government bonds, which is a part of the market that could come under increasing pressure if we head towards a no-deal Brexit,” said Mohammed Kazmi, a portfolio manager at Union Bancaire Privee SA, which has lowered its exposure to Ireland and replaced it with Spain.
That chimes with views among other fund managers contacted by Bloomberg. Anton Nykvist of Nordea Investment Management AB was overweight on Irish bonds until late July due to the country's solid growth outlook and improving debt metrics. Ireland's 10-year bonds have returned investors 11 per cent this year, outperforming the 8 per cent gain in a Bloomberg Barclays index for euro-area bonds. Yet in August Nordea also moved to sell the debt in favor of Spain.
“Markets and sovereign spreads were not pricing in a hard- Brexit scenario and its quite severe estimated consequences for the Irish economy,” said Nykvist, pointing to a potential hit of up to 6 per cent to the nation’s gross domestic product. “We feel we have a better understanding of Spanish politics than the quite frankly hard-to-follow Brexit situation.”
Ireland's Finance Minister Paschal Donohoe has said 80,000 Irish jobs might be at risk in a hard Brexit, while Foreign Minister Simon Coveney has said in a worst-case scenario Ireland would have to be careful to avoid getting taken out of the EU's single market itself. Its land border with Northern Ireland remains the key roadblock to the U.K. getting an exit deal with Brussels.
As proxies for the economy, Ireland's banks are especially exposed to any fallout from Brexit. Bank of Ireland Group, which postponed a bond sale this week, is down more than 20 per cent this year. A no-deal Brexit would hinder plans to reduce non- performing loans, according to a Fitch Ratings report earlier this year, while S&P Global Ratings said it would challenge an economic recovery and increase pressure on the credit ratings of Irish issuers.
A weaker economy without sovereign risk might not lead to a big selloff in Irish bonds, given the UK's gilts have rallied as a haven on Brexit and the European Central Bank is expected to resume an asset-purchase program this year that would prop up the region's debt.
Ireland’s longer-term debt still offers investors positive yields, at a time when many in the euro area have fallen below zero. Ronald van Steenweghen, a portfolio manager at Degroof Petercam Asset Management in Brussels, would view any nervousness in the event of a no-deal exit as an opportunity to buy.
Spread risk
The bonds are already starting to lag peers. The premium between Ireland’s bonds and Europe’s safest has been climbing since Johnson became U.K. prime minister. The Ireland-Germany 10-year yield spread is up 15 basis points since mid-July to 58 basis points, having narrowed earlier in the year.
Uwe Maderer, a portfolio manager at Deka Investment, has been watching the bonds lose ground every day and spreads hitting record highs against similarly-rated euro debt from Slovakia. He has started selling Irish 30-year bonds as a Brexit hedge.
"If a no-deal happens, Irish bond spreads will widen further as markets will be unnerved by the step into the unknown," said Jon Day, a fixed-income portfolio manager at Newton Investment Management. "We would expect spreads to widen towards 100 basis points over Germany." – Bloomberg
