LONDON: Portugal's borrowing costs tumbled to six-week lows on Monday after it passed a crucial ratings test, while yields in neighbouring Spain fell sharply on signs that 10 months of political deadlock may be near an end.
Ratings agency DBRS maintained its BBB (low) rating with a stable outlook for Portugal late on Friday, maintaining the investment-grade rank the country needs to keep its position in the ECB's massive bond-buying programme.
That sparked a relief rally in Portuguese bonds, sending 10-year yields down as much as 15 basis points to 3.05 percent .
In Spain meanwhile, conservative leader Mariano Rajoy was set to secure a second term in power for his People's Party after the Socialists agreed on Sunday to abstain in a confidence vote to be held this week.
That pushed Spanish yields down 5 bps to just over two-week lows of 1.06 percent.
The country has been stuck in political limbo following national elections in December and June which left no single party with a majority, paralysing institutions and threatening to derail an economic recovery. As risks facing Portugal and Spain ebbed, their southern European peer Italy could become the main underperformer as it faces political uncertainty ahead of referendum on constitutional reform on Dec. 4.
"There's generally good news all around in terms of risk towards the periphery following the ratings news on Portugal and signs that we'll get a new government in Spain," said Orlando Green, European fixed income strategist at Credit Agricole. "The elephant in the room remains Italy, with the referendum looming."
Fitch Ratings, which left Italy's BBB+ rating unchanged late on Friday, said it had cut the outlook to negative because of weak growth, high debt and the uncertain outcome of the referendum. Italian bond yields were down 2 bps on the day at 1.35 percent, lagging the sharp falls in Spanish and Portuguese bond yields.
STAR PERFORMER PORTUGAL
Portugal stood out as the region's biggest mover. While 10-year bond yields pulled back from their lows as the session wore on, they remained 8 bps lower on the day, outperforming euro zone peers following the DBRS review. DBRS cited Portugal's "adherence to the EU economic governance framework," including progress in reducing its budget deficit as reasons for keeping the investment grade rating.
The Canadian firm is the only one of the big four ratings agencies that rates Portugal at investment grade. Uneasy anticipation about its decision had weighed on Portuguese markets since August when DBRS warned that pressures were building on the country's credit worthiness.
But a promise of budget deficit cuts next year had helped to soothe market nerves, with Portuguese bond yields moving lower last week in anticipation of a positive outcome to Friday's review. "There would have been a negative impact if we'd seen a downgrade, so it's probably right that we're seeing a bit more of a relief rally today," said Patrick O'Donnell, investment manager at Aberdeen Asset Management.
"This means the Treasury is likely to come to the market to take advantage of more favourable conditions to issue more bonds and that could temper any rally." In other ratings action, S&P raised its outlook on France's "AA" long-term sovereign credit rating to "stable" from "negative" on Friday, citing labour and tax reforms introduced in the last two years. French 10-year bond yields were down 2 bps at 0.26 percent , slightly outperforming top-rated German Bunds.
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