Draghi’s Stakes Higher as SNB Adds to Delivery Risk: Euro Credit

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(Bloomberg) — Stakes in the bond market were already high for Mario Draghi. Then the Swiss National Bank raised them.

Government bond yields across the euro region had tumbled to record lows in anticipation of the European Central Bank president announcing a debt-buying program at its meeting Thursday in Frankfurt. That investor speculation deepened when Switzerland’s central bank last week let the euro begin to fall against the franc for the first time in three years.

Pioneer Investments says the quantitative-easing program has wormed its way into bond prices, so it’s positioning to benefit from a drop. The risk is that Draghi doesn’t deliver, or the plan is perceived as too small, and the 13 percent rally in the region’s bonds in the past year starts to unravel.

“It is priced in, so I’d rather be short,” said Tanguy Le Saout, Dublin-based head of European fixed income at Pioneer Investments, which oversees about 200 billion euros ($232 billion). “In terms of positioning, people are not short the euro bond market any more. We are short on Italy and we are bearish on the bond market as a whole.”

With a different view, investors including JPMorgan Asset Management and Santander Asset Management Espana have bought government debt of Europe’s periphery nations, foreseeing their rally extending on the ECB decision.

Record Yields

Government bonds from Austria to Portugal have jumped, pushing yields down to record lows, on bets that Draghi will introduce fresh stimulus to stave off deflation and revive growth which can complement earlier steps. They included introducing a negative deposit rate, and purchases of asset- backed securities and covered bonds.

The SNB’s decision to let the franc trade freely against the euro fueled speculation that the ECB was preparing to buy bonds, in quantitative easing. QE potentially debases a currency, and it may weaken the euro further against the franc.

ECB officials in Frankfurt will announce a 550 billion-euro ($638 billion) government-bond purchase program tomorrow, according to 93 percent of respondents in a Bloomberg News survey. The median estimate of the size of the package tops the 500 billion euros in models presented to officials this month.

“Market expectations have built up to such an extent that should they not announce QE, it will come as a negative shock to the market,” David Tan, London-based head of global rates at JPMorgan Asset Management, said in a telephone interview. “The probability of an announcement is very high.”

Overweight Positions

The company is overweight peripheral notes with maturities of three to four years also because economies of those nations outside the European core are showing signs of improving, Tan said. An overweight position is one in which an investor holds a bigger percentage of a security than is contained in the indexes used to monitor performance.

Francisco J. Simon, money manager at Santander Asset Management Espana in Madrid, said he is buying 15-year Spanish and Portuguese sovereign debt as yields in the region’s periphery converges with those in in the core. The additional yield investors demand to hold Spanish 10-year debt over equivalent-maturity German bunds reached 97 basis points on Jan. 2, the least since May 2010. That compared with an average 20 basis points before the sovereign-debt crisis.

Prospects of bond purchases received a further boost with German Chancellor Angela Merkel’s signal that she won’t oppose them, saying in a speech near Frankfurt late Monday that her only request was that any ECB action doesn’t ease pressure on governments to pursue reforms.

“They have to come up with something,” said Daniel Lenz, lead market strategist for the euro area at DZ Bank AG in Frankfurt. “There would be a high risk of severe profit-taking if there was nothing coming. They have to announce something that’s for sure. Whether they already start implementing the program, we can’t be sure about this.”

–With assistance from Max Julius in London.

To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at [e-mail]; David Goodman in London at [e-mail] To contact the editors responsible for this story: Paul Dobson at [e-mail] Todd White, Mark McCord