It is now over six and a half years since the introduction of the euro, and in a recent article, PIMCO’s Emanuele Ravano suggests that the Euro-zone’s bond market should be viewed as perhaps the politicians’ biggest success story.
Many of the statistics speak for themselves: The euro government bond market is almost twice the size of the US government market; the average issue size of individual euro Govvies has doubled since January 1999; and the euro market’s long-term bonds (longer than 15-year maturities) far outweigh those of the US. And it would be hard to ignore the huge growth in the euro inflation-linked market – a whopping 33-fold increase.
Ravano and his team at PIMCO Europe suggest that, in this time of growing focus on pension liabilities, there will be a greater demand in markets that can provide sufficient liquidity in long duration bonds. They argue that there could be some interesting cross-border flows given the Euro-zone’s clear advantage in size.
Outside the government-issued sector, the number of corporate issues has fallen by one third but alongside this decline has been a tripling in average issue size. There has been a significant move towards diversification in the investment grade market, which was largely made up of banks in 1999, while today the financial sector accounts for around 50%. The proportion of bonds at the lowest end of the investment grade spectrum (A/BBB) has grown from about one quarter to nearly three quarters of the whole. Interestingly, this is the opposite of what occurred in the US over the same time period.
Within the corporate sector, Ravano cautions that its success could mean higher volatility, as hedge funds seeking liquidity for their trading might look to European corporate bonds which should result in greater volatility in corporate spreads over government bonds. Also, he suggests that the explosion in issuance of synthetic CDO’s (collateralised debt obligations) further supports the argument for higher future volatility because of the leverage used in their creation.
And there has been a 24-fold growth in the high yield market, but this only takes the high yield share of the euro aggregate index to 1% and there are only around 180 issues. As Ravano points out, that leaves a way to go before it gets near the US high yield market, which has 1,975 issues accounting for 7.5% of the respective aggregate index.
PIMCO argues that the remaining area of weakness are the lack of depth in the T-bill market where the US remains clearly ahead, and the fact that the euro high yield market still has a fair way to go. Ravano suggests that, in the absence of a deeply diverisified high yield market, investors should, for the meantime, widen their outlook and include bank loans to non-financial corporations, which amounted to 41.0% of GDP and 70% of bank financial assets.