Friday, August 5, 2011

Bond yields fall and S&P are happy

After a year of almost unrelenting increases Irish government bond yields have been falling for the past two weeks.  The recent drop only goes some way to offsetting the increases that took place over the past year.  Here is the 10-year bond yield constructed by Bloomberg.

Bond Yields 1Y to 05-08-11

Although the recent drop has been rapid, the 10-year yield is only back to where it was at the end of April.  There is still a long way to go before these yields give any indication that Ireland can return to raising funds on bond markets.

That would require a drop to around 5% or so.  As it is we have yet to drop below 10%, but dropping through this level is something that could happen in the next day or so.  Trading today has seen the yield hover around 10.2%.

Bond Yields 1D 05-08-11

The movements in Irish bond yields are running counter to all of other fellow PIIGS (Portugal, Italy, Greece, Spain) who are continuing to see rising yields, albeit only moderately.   The actual yields and yesterday’s closing prices off all Irish government bonds can be seen in this daily report from the NTMA.

[UPDATE: The Irish ten-year yield produced by Bloomberg finished the day at 10.024%. Chart here.  Getting below 10% is not far away.  It finished as a reasonably good day for the PIIGS with only Greece seeing rising yields on the day.]

The news on Ireland today was further boosted by a statement from S&P this morning confirming our BBB+ investment grade rating for Irish government bonds with a stable outlook.  BBB is two notches above speculative or junk status and is defined as “adequate capacity to meet financial commitments, but more subject to adverse economic conditions”.

Here is the S&P view of Ireland’s public debt:

We expect Ireland's net general government debt burden will peak at about 110% of GDP in 2013, including NAMA's debt obligations, before falling to about 103% of GDP in 2015. Excluding NAMA obligations, we expect net debt to peak at around 97% of GDP in 2014.

This is a long way from what some domestic commentators are trying to predict.  The full S&P statement is reproduced below the fold and in general it is reasonably positive.

The ratings on the Republic of Ireland reflect our view of the government's commitment and capacity to stabilize public finances following a severe banking crisis and a structural deterioration in the fiscal balance. We believe that Ireland's creditworthiness is sustained by a strong political consensus in favor of fiscal consolidation, which should reduce the general government deficit to around 3% of GDP by 2015. We also view Ireland's competitiveness gains since late 2008 and open economy as being supportive of modest, export-led economic growth over the medium term.

In our opinion, the Irish government's fiscal strategy should be capable of putting the public finances on a more sustainable path. Following the Heads of State or Government of the Euro Area and EU Institutions statement of July 21, 2011, we expect the interest rate on the European Financial Stability Facility (EFSF: foreign currency AAA/Stable/--) portion (€17.7 billion) of Ireland's €67.5 billion external support package to decrease to about 4.5%, from about 6.0%. We estimate the saving to the Irish government on interest payments will be around €0.9 billion (0.6% of GDP) cumulatively over 2012-2015. The maturities on EFSF loans are also expected to be lengthened as part of the Heads of State agreement. Meanwhile, it is also possible that interest rate reductions will be extended to Ireland's European Financial Stability Mechanism (€22.5 billion) and bilateral borrowings (€4.8 billion).

In our view, the Irish government has sufficient funding under its external support package to cover its financing requirements until the second half of 2013. At this time we expect Ireland will look to refinance a €11.9 billion bond maturing Jan. 15, 2014. We expect Ireland's marginal funding costs at this time to have declined to rates of around 6% or lower, a level that in our view would not put the government's debt dynamics at risk. Such funding rates would, we believe, be commensurate with the Irish government's success at convincing the capital markets that its primary fiscal balance and growth prospects are sufficient to put the public finances on a more sustainable path. On the other hand, any failure to meet these fiscal targets or to restore growth of the domestic economy could imply locking-in higher nominal interest rates, which we believe would likely damage debt sustainability.

As well as attempting to halve the 2010 structural deficit of around 10% of GDP by 2015, the Irish authorities are also contending with the aftermath of a severe banking crisis. In our view, the assumptions underlying the central bank's Financial Measures Programme were robust (see "Ireland's Ratings Lowered To 'BBB+/A-2' And Removed From CreditWatch; Stable Outlook Reflects Credibility Of Stress Test," April 1, 2011) and we do not expect any further material costs to the government of supporting the domestic banking system over and above the €64 billion (41% of GDP) in capital already injected and the €28 billion (18% of GDP) in National Asset Management Agency (NAMA: local currency BBB+/Stable/A-2) debt securities issued (see Related Research below).

We expect Ireland's net general government debt burden will peak at about 110% of GDP in 2013, including NAMA's debt obligations, before falling to about 103% of GDP in 2015. Excluding NAMA obligations, we expect net debt to peak at around 97% of GDP in 2014.

In our view, Ireland is the most open economy in the euro area, with exports estimated to exceed 105% of GDP and on track to expand an estimated 7% in volume terms this year. In absolute terms, Ireland's merchandise trade balance, which hit an all-time high of US$48 billion (31% of GDP) in 2010, is the third highest in the euro area, despite Ireland's position as the twelfth-largest economy in the EU-17. Due to its openness, Irish output is sensitive to any potential external demand shocks, as well as to the level of the real exchange rate (which has been depreciating due to declining nominal wages). Most of the gross value added from Ireland's export sector gets transferred abroad via dividend payments. Moreover, the international tradables sector has so far contributed little in the form of new employment to the Irish economy. Nevertheless, the second round impact of the export sector on job creation, domestic incomes, and public finances should not be understated.

Standard & Poor's projects that Ireland's real per capita GDP will increase by 0.3% during 2011, driven exclusively by net exports and accelerating toward 2.0% by 2014. We expect real domestic demand will continue to decline until 2013 and could be further depressed as the European Central Bank (ECB) embarks on a monetary policy tightening cycle. At end-2010, 86% of Irish residential mortgages carried flexible interest rates. Meanwhile, external demand could also weaken.

The 'AAA' T&C assessment, which applies to all EMU members, reflects Standard & Poor's view that there is an extremely low risk of the ECB restricting access to foreign exchange needed for debt service.

The stable outlook reflects our view of the balanced risks to Ireland's creditworthiness. However, if the government doesn't achieve its fiscal strategy, downward pressure on the ratings could build. Alternatively, were the economy to return more quickly to average real GDP per capita growth rates above our current expectation of 1.6% during 2011-2015, we could consider raising the ratings.


  1. Hi Seamus,

    Do you have any view on the S&P assessment peak debt:GDP will be 110% including NAMA (18% apparently) and the banks (41% apparently). In other words, without the banks or NAMA, the debt:GDP would apparently be 51%.

    How does that sit with your recent indepth analysis of some other projections?

    Sorry the question is slightly tongue in cheek, but your comments would be welcome.

  2. Hi Jagdip,

    I have just put up a post that might address some of your issues in relation to the S&P debt forecasts. They seem ok to me, but are not based on universal debt measures.

    I don't think your calculation here is right. The 18% and 41% of GDP for NAMA and the banks are based on 2010 GDP. The 110% total net debt forecast of 110% is based on 2014 GDP. The denominators are different so these percentages can be added together in a simple sum.

    S&P themselves indicate that they believe NAMA obligations will be 13% of GDP in 2014 (110% minus 97%).

    They are not saying that without NAMA and the banks net debt/GDP would be 51%. Such a figure would probably be something around 60% but I'm not sure it makes much sense anyway.