(April 24): The traditional hierarchy of debt in Europe is facing its latest shake-up as worsening public finances in Belgium threaten to turn some of the region’s once-safest bonds into a risky bet.
Belgium is undergoing fresh scrutiny following Moody’s Ratings downgrade last week, with S&P Global Ratings set to review its sovereign rating later Friday. ABN Amro Bank NV warns markets are yet to price in “fiscal gloom”, while money managers at Candriam and Mediolanum say the situation shows why they prefer to own securities elsewhere in Europe such as Spain.
The distinction between Europe’s safest and riskiest bonds, forged in its debt crisis over a decade ago when the likes of Spain, Portugal and Ireland all needed bailouts, is now fading. Borrowing costs for Belgium, home to the European Union’s institutions, have climbed above all of those so-called “peripheral” countries.
“The situation in Belgium remains fragile,” said Nicolas Forest, the Brussels-based chief investment officer at Candriam. “We believe that an additional downgrade could put further pressure.”
Forest maintains a preference for Spanish and Portuguese bonds over Belgium and expects the gap between the latter and France’s borrowing costs to close.
Belgian 10-year yields currently trade less than 10 basis points below those of France, whose own standing has been hit by a succession of collapsed governments and budget wrangles. Both countries were seen by bond veterans as among the “core” of Europe’s debt, leaving just Germany to be considered as a bond haven.
“Belgium is typically compared with and traded against France,” said Ales Koutny, head of international rates at Vanguard. “One can argue that Belgium’s fiscal position is deteriorating more rapidly than France’s.”
While the latest surge in Belgian yields has been driven by worries about inflation and energy security following the war in the Middle East, they have been grinding higher for several years. Moody’s downgrade of Belgium to A1 followed an equivalent cut from Fitch Ratings last year.
The next catalyst for a selloff could come from S&P’s assessment of the country. Its current rating at AA — two notches above the scores of Fitch and Moody’s — has been skewed toward a possible downgrade for the past year.
“We continue to favour euro-area sovereigns with a clearer path to fiscal improvement, such as Ireland and Spain,” said Niall Scanlon, a fixed income portfolio manager at Mediolanum.
Belgium’s finances are being hurt by the rising borrowing costs, an ageing population, and increased defence spending. Its debt is set to rise at a pace second only to the US among advanced economies, according to the International Monetary Fund, with the ratio to gross domestic product seen reaching 122% within half a decade. That would be the biggest in Europe after Italy.
Still, the market’s reaction has so far been relatively muted. While ratings downgrades risk forcing funds with ultra-strict investment criteria to sell a country’s bonds, some investors tweaked their benchmark rules last year to avoid forced liquidations as France got downgraded.
The spread of Belgian bonds over Germany — long seen as the region’s safest — has widened three basis points this week, to 57 basis points.
Larissa de Barros Fritz, a fixed income strategist at ABN Amro, expects that to escalate. Alongside Belgium’s existing debt woes, she points to vulnerability stemming from its energy-intensive economy.
“Spreads are not yet fully pricing in the gloomy fiscal situation in Belgium,” she said, forecasting a widening to 70 basis points this year. “Belgium is one of the EU countries most exposed to energy supply disruptions coming from the Middle East.”
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